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We know markets like to “climb a wall of worry” but sometimes we think they are not in touch with reality. For the last few months, if we look at bond yields, the falling yields imply inflation has been beaten and the Federal Reserve has raised rates too many times. So much so that predictions continue to bolster the idea that interest rates will need to be cut before Christmas.

We are not sure if we were listening to the same speech from Mr. Powell this week, because it seemed to us that he has no intention of cutting rates this year and if inflationary pressures continue to rise, he will need to raise rates later this summer. That was on Wednesday, a day the S&P fell 29 points and the Dow dropped 270 points. In percentage terms, it is not an alarming drop, but the Dow fell a further 287 points on Thursday effectively erasing all of the gains for 2023. It should not have been a total surprise given US Q1 Unit Labor Costs jumped 6.3% versus 3.3% in Q4.

To us, a hot jobs data number would just add more gas to a small fire. And we got it. 235,000 more jobs in the US (the guess was around 180,000 new jobs) virtually all of it in the private sector plus average hourly earnings rose by 0.5% in April versus 0.3% in March. So, what happened?

Wall Street rejoiced. Clearly the fastest increase in interest rates since the late 1970’s was not yet dampening the strength of the US economy. It implies Q2 earnings are off to a good start, removing the funk over Q1 earnings. Take Apple for example. The stock jumped $7.37 or 4.46% today following an “earnings beat” yesterday. Apple reported net earnings of $24.16 Billion or $1.52 per share, raised their dividend by 4% and announced a $90 billion stock buy back. Ok those last two items plus a positive outlook by CEO Tim Cook would justify a bounce in the stock, but if you look at the numbers, you might not want to jump in with both feet. Revenues year over year fell from $97.2 billion to $94.8 billion. Net income fell from $25 billion to $24.16 billion. And thanks to buy backs last year, EPS were flat at $1.52.

If nothing else, it shows you short Apple at your own financial risk. As a company it is head and shoulders above the crowd because Apple followers will stay faithful regardless of conditions. It trades at a significant premium to the S&P just as Microsoft does and we don’t see a reversion to the mean anytime soon.

Now, where does that leave investors? We would argue for continued caution and a continued pivot to value, over growth. The US banking crisis continues unabated. We continue to be shocked by the lack of action from regulators who seem to be either oblivious to the shenanigans by hedge fund managers destroying their banking system or in a severe state of denial thinking the First Republic Bank bankruptcy will be the last. Short sellers can short these names with near impunity and let me explain how. There are specialty Exchange Traded Funds that own a basket of mid size US banks in fairly large weights.

Step one. Hedge funds shorts a couple of the larger weighted holdings like First Horizon Corp and or East West Bank corp.

Step two. Short the SPDR S&P Regional Banking ETF knowing that as volumes increase, the ETF providers, who must provide liquidity, will turn around and sell the pro rata positions in each of their holdings including FHN and EWBC.

Step three wait for the media to latch on to the idea that those banks could be in trouble and may need a bail out.

Step 4 wait for depositors to read the headlines and move their chequing and Savings to a big bank.

Step 5 now that the stock has collapsed cover part of your position at a sinful profit but wait for the FDIC sweep in and force a takeout wiping out the bank. If you don’t believe us, look at KRE aka the ETF. It traded 117 million shares on Thursday versus a long-term average of 55 million per day. First Horizon traded 120 million shares that day versus a daily average of 20 million. Oh, and that one fell 30% yesterday.

It boggles our mind, and we think it will cause a significant drop in consumer credit as bank after bank looks over its shoulder worrying that they will be next. If the trend continues, their banking system will look much like ours, aka half a dozen super banks with enough political and economic clout to effect policies that work to their benefit.

We hope regulators or politicians wake up and provide real mechanism to stop the meltdown.

Stay safe and Happy trading.

Steve Bokor and the Ocean Wealth Team

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