The Dividend Cafe - The DC Today - Tuesday, April 4, 2023

Episode Date: April 4, 2023

Today's Post - https://bahnsen.co/40EOqh5 First of all, congratulations to the Huskies of the great state of Connecticut (where some of TBG’s favorite clients reside) on their NCAA championship. I assure you it was the news story today that deserved the most press coverage. It was a pretty boring day in the market, and all the news wanted to talk about was the Trump court appearance and such. Bonds rallied quite a bit. Stocks had their first down day in a week. The Q&A’s below dig into a key issue of understanding the stress in the banking system right now and a key issue about the Fed. Scroll down if interested. Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com

Welcome to the DC Today, your daily market synopsis of the Dividend Cafe, brought to you every Monday through Thursday to bring you up-to-date information and perspective on financial markets. Well, hello and welcome to thewall coverage of the news cycle, which you may have noticed is quite focused on one particular story and, as best I can tell, no other, which has meant that the Huskies of the University of Connecticut have not gotten enough kudos today for their national championship win. Congratulations to the great state of Connecticut, where TBG has some of its very favorite clients and where they now have another men's basketball championship, well deserved after a great tournament. In terms of markets today, it was a pretty boring day. Bonds

were up quite nicely. Stocks were down a little bit, though it was the first down day in a while in stocks. The Dow was down 199 points. The S&P was, actually, Dow, S&P, and NASDAQ were all down basically right around 50, 55 basis points. And so very similar percentage downside for all three of the major equity indices. Within the S&P, utilities were the best performing sector. It's very rare that utilities will ever be the best performing sector on a good day in the market, just as a general rule of thumb. But when you have a few of the defensive sectors leading the way, including in the positive territory, utilities were up about 50 plus basis points. positive territory, utilities were up about 50 plus basis points, then it usually means some other less defensive and more cyclical sectors were down when it's a down day in the market. And that was the case today with industrials, which were down over 2% and were the worst

performing sector. The 10-year closed at 3.33%, the 10-year bond yield. So you are really dealing with a massive rally in bonds, as I've talked about several times in recent days and weeks. And oil closed at $81 a barrel. It was up not quite 1%, but moved up again today after yesterday's big move higher. So that's the scoop in markets today. In terms of the issues I'm going to quickly talk about just for a sort of peripheral financial topic of the day, the Q&A, the Ask David section in DC Today, both dealt with questions related to banks and interest rates, and then one around the Fed. And there are separate questions, but I want to cover it for you that are listening and watching. So if you don't read the DC today,

you're not being left out of this information. The question had to do with whether or not banks that are paying out a higher rate of interest in deposits right now to secure new clients, and then when interest rates drop or at risk of losing those clients and creating another banking crisis, I think that the problem with that question is that there's sort of a flaw in the way a lot of that system works. And also the fact that if and when, well, not if, but when interest rates come lower, that they're going to go lower for everybody. And so there isn't necessarily a reason to believe that depositors are going to leave Bank A because rates went lower to go to Bank B where rates also went lower. Now, in theory, are there

some who only came for a higher rate that then may be more likely to leave? That's certainly true. It's not usually the stuff systemic crashes are made of. But what I want to point out is that there are two levers by which a bank controls its profitability. It's the essence of a bank business model. And that when the bank is seeing a higher interest rate environment, that they have one thing working for them, one thing working against them. What's working against them is that depositors often will want a higher rate of interest paid. And the more the bank is paying out, that's less earnings to the bank. And there's more competition for those deposit funds because treasury bills or money market funds, which is really where you're seeing a lot of pressure now, can draw deposits out of a bank as people want to push that cash

in place in search of some yield. But then on the other hand, there also is the ability to charge a higher amount for money the banks lend out. So they're in both the deposit business and the lending business. And the ability to capture more spread on lending money out is enhanced. And so the banks have two levers by which they can make money lending out at higher rates and having your deposit rate be lower than what you're receiving in interest on your bank reserves. And then they have two ways in which they can compete. And that is by paying more out in deposits. So get you more business, but weighs on profits. And then lending money out at a lower rate than some may be doing competitively. Get you more business, but cuts into your profits. So that's just the simply stated

reality of banking. And there's two different levers there. And banks that act crazy on both levers can face existential risk and those that don't, don't. But this is a very time-tested model of more boring commercial banking. And the notion of deposit rates coming lower in the future and then therefore causing a lot of bank depositors, I don't believe that will happen. And by the way, the argument there works against the fundamental premise of the question, because in theory, if someone moved money from bank A to bank B, and now bank B has a lot of new hot money because of high deposit rates and rates drop, it's very possible Bank B will lose some of that hot money it brought over from Bank A. But because we know

that there are hundreds of billions of dollars that have left Bank A and Bank B to go to money markets, if rates were to drop in money market funds, you could argue a lot of those deposits may come back to Bank B, for example. So there's a kind of two-sided coin situation. The other question somebody had asked was about the Fed taking losses right now and classifying it as a deferred asset and if this means anything scary. And I don't think very many of you are thinking about this. And I appreciate some of the financial jargon in it may be a little bit heady for some or boring or disinteresting. But if you're still listening, I'm guessing you don't feel that way. And I want to be clear as to why this is not an existential threat at all. And in fact, is mere bookkeeping. No one

gets excited about the fact that when the Fed levered up their balance sheet with greater quantitative easing and therefore was receiving more interest income from all those bonds that they owned and that they were remitting the profits out to Treasury, the Fed is not allowed to be a profit-making entity and it's not designed to be a risk-absorbing or loss-absor absorbing entity either. And so what they do is when they made profits, which averaged of us 10 years, about $80 billion, they would defer that money to the treasury. They would pay that out.

But then when they lose money, meaning all of a sudden now they're paying out more in interest on bank reserves than they're collecting from their bond portfolio. What they do is they hold that differential as something called a deferred asset on their books. And when they do get back to a place of positive cash flow and net interest margin, that amount will have to be paid off before they end up having to pay out to the Fed. So there's really just nothing solvency oriented. There's nothing substantial. The total amount of deferred assets that have accumulated is $44 billion over the last over a year. And that's on an $8 trillion balance sheet. So it's very, very, very small potatoes. And again, it's a bookkeeping thing because that interest margin will go positive again, and they will have a delay until they

have to start paying treasury back. I doubt many of you are thinking about it, but I want you to understand how that works. I want you to understand where our focus on the Fed is not so much with ambiguous headlines that people can tweet things that they don't really know what they mean. We want to be focused on what is a real threat from the Fed or a real concern. And obviously I talk about that stuff all the time, not get caught up in the weeds of things that I don't think very many people truly unpack well. Same with the banking system and hence the conversation a moment ago about deposit rates and all that. So there's enough boring financial banking jargon and education for you for today. Thank you for listening. Thank you for watching.

Thank you for reading the DC Today. I will be bringing you the DC Today tomorrow, but I'll be hitting send from a airport as I get ready to fly back to New York City for I think I'll be over a week of meetings and things. So lots going on in the world. And congratulations again, UConn. Take care. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Advisors LLC, a registered investment advisor with the SEC.

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