Fed’s Balance Sheet Bingo
Two American banks failed. A few more – including a pretty big international bank, Credit Suisse (NYSE: CS) – weakened to the point that action was required. So the powers that be – ie the Fed, the Treasury and other banks – have stepped up to offer a backstop intended to assure account holders that they don’t need to pull their funds out.
Because, a bank run is an irresistible force that accelerates on its destructive momentum. No bank is liquid enough to have ready cash to meet a flood of redemption demands. Account holder cash is tied up in loans and other investments, even safe ones like Treasury bonds. Fact is, any bank that does carry 100% of depositor funds in cash is not a very good bank at all. Gotta put that cash to work…
Now, with regard to long standing problems at Credit Suisse, that’s Switzerland’s problem. Considering the amount of ill-gotten cartel and oligarch booty that runs through the Swiss banking black box, it’s not a huge surprise Credit Suisse got a big cash injection before heads literally started rolling…
But what we need to talk about is the solution that the Fed and the Treasury Department just engineered for America’s regional banks. The big investment banks – JP Morgan, Goldman Sachs, Bank of America and the like – agreed to drop $30 billion into the First Republic Banks’ (NYSE: FRC) coffers, to say to the average account holder yes, your accounts are fine.
I love the thought of Treasury Secretary Janet Yellen sitting down with the Dons of the big banking families – Goldman, Morgan Stanley, JP Morgan et al – and issuing the veiled threat: “so, that’s a pretty nice bank you got there, sure would be a shame if something happened to it…”
Funny stuff.
But the long and short of it is – the Fed’s lending window is wi-i-i-de open, and the news will tell you that the Fed’s balance sheet just jumped by $297 billion dollars over the last week. You’ll probably see a chart that looks like this…
Source: Federal Reserve Bank of St Louis
And that chart will probably be accompanied by some judgey commentary about how the Fed has gone right back to quantitative easing, pumping up the money supply and stoking inflation at the same time its *trying* to bring inflation down with interest rate hikes…
Now, first of all, if you’re an investor and you can’t admit how much you love Fed stimulus and money-supply inflation, well…let me refer you to the post-pandemic stock market, or the post GFC market or really any market environment that’s underpinned by low interest rates and easy money…
Because when the Fed is pumping, stocks rally and it is AWESOME!!
C’mon you know I’m right. When the money supply is growing, we can jump on the most bullshit new EV battery tech story or Bitcoin to a million dollars or Artificial Intelligence crap and Ba-BOOM – the stocks launch and we’re all bull market geniuses…
So IF it were true that the Fed’s balance sheet increase was actually a return to the glory days, I’d be right there, pom-poms and all…
But, sadly, I gotta tell you…
Yep, the Fed isn’t pumping up the liquidity at all. In fact, it’s pretty much the exact opposite…
Cash for (Impaired) Assets
So, the big banks put a bunch of cash in First Republic Bank. But did they just send along some of the piles of dollars they have in the vaults? Oh no, dear reader, that’s not how this works…
You recall the discussion we had about Tier One Capital the other day? How banks take a portion of account holder money and put in Treasury bonds to make a few percentage points of profit? And how Treasury bonds that were bought when yields were 2% are not worth as much as they are now that yields are 4% and 5%?
Well those are the assets that are going onto the Fed’s balance sheet.
And the Fed is paying out a dollar on assets that are worth less than a dollar. Pretty good deal, no wonder banks are jumping all over it, right?
And it’s easy (lazy?) to think that this an inflationary move, after all, banks are essentially getting more cash for the assets they send to the Fed. But for it to be inflationary, these funds would have to find their way into the economy via lending.
But the thing is, the assets that are downpouring onto the Fed’s balance sheet are collateral. The big banks may have sent $30 billion in cash to First Republic bank, but that money will absolutely not be backing a bunch of new loans. It’s there to create confidence and prevent bank runs. If anything, First Republic will be tightening lending standards in order to keep that cash right where it is…
And the big banks will be tightening lending standards too.
What we are witnessing right now isn’t inflation at all. Liquidity is drying up even faster. And right as we’re staring recession in the face…
Know What You Own
Now I know, I just suggested that new EV battery tech is BS and AI is crap. That was hyperbole meant to serve my point that story stocks or emerging tech stocks or whatever you want to call them do very well when cash is plentiful. What we need to talk about now is how these stocks will fare when cash is not so plentiful…
Because when cash is in short supply, investment banks, hedge funds and individual investors will sacrifice even the most promising stocks in favor of a nice bankroll. And that means two things for us…
One, there will be plenty of opportunity to buy stocks at low prices. And two, we must focus on stocks that have promising growth for when the economy returns to a bullish trend, but that also have the financial strength to get there.
It’s probably gonna get worse for electric vehicle stocks. I told you I like Fisker (NYSE: FSR), but it doesn’t have the strongest cash position. I’d rate it a distant second among the emerging EV makers, after Rivian (NASDAQ: RIVN). Rivian has an $11 billion market cap right now, and it has $11 billion in cash. Both companies will survive and thrive, but Rivian is the EV stock to target with an incremental buying program.
While I like the potential for battery maker Quantumscape (NASDAQ: QS) to prosper, the fact is it is valued at $3.5 billion, has $900 million in net cash and hasn’t really started ramping production. It will probably need to raise cash, makes sense to wait for that to happen if you want to own it.
Artificial Intelligence is an obvious sector to target. And because of its large base of paying customers, C3.ai (NASDAQ: AI) is another stock to target. Its market cap is $2.3 billion and it has $765 million in net cash. That’s solid, but it’s reasonable to expect customers to tread lightly over the next few months, so add shares slowly.
Bank of America (NYSE: BAC) has long been my favorite bank stock to own. And the beating that bank shares have taken over the last two weeks has them starting to look attractive. For BofA, there’s a glaring gap on the chart at $25 – that’s the place to buy it.
Aehr Systems (NASDAQ: AEHR) is hanging right on its 50-day moving average at $32. But the 200-day moving average is way down at $20. Prospects are great, ~50% revenue growth and solid profitability ahead. I’d feel much more confident buying it around $25.
I’m leery of oil stocks in general, given the economic climate. Recession is never good for oil prices. But I can’t ignore the ridiculous dividend at Petrobras (NYSE: PBR).
Finally, take a look at Canadian Solar (Nasdaq: CSIQ) – $1 billion in cash, $7 billion in revenue and a forward P/E of 7. It’s been dropping ahead of earnings next week, starting a small position at current levels seems reasonable.
Of course these aren’t the only stocks that are – or will be – attractive over the next few months. Point is: I think the investment landscape is about to get more challenging and it’s going to be very important for us all to be discerning, even skeptical, about buying stocks. Like, instead of thinking only about the potential, ask yourself “what could go wrong?”
Because the fact is, the problems just coming up in the banking sector could be just the start…
As always hit me up on Twitter or email if you have questions are or comments.
That’s it for today, take care and I’ll talk to you Monday…
Briton Ryle
Chief Investment Strategist
Pro Trader Today
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