NEW YORK, March 25 (Reuters) – Investors are bracing for a long slog in the US stock market in the coming months, bracing for more turmoil in the banking sector and worrying about how Federal Reserve tightening might unfold will affect the economy.
Concerns over the banking sector led to sharp moves in financial stocks in the United States all week following the collapse of two US lenders and the Swiss government-orchestrated takeover of ailing Credit Suisse (CSGN.S) by rival UBS (UBSG.S ) last weekend.
Many fear there are other nasty surprises in store as the Fed’s rapid rate hike hike over the past year dries up cheap money and widens cracks in the economy.
“The market is very nervous at this point and investors are acting first and looking at the nuances later,” said Wei Li, global chief investment strategist at fund giant BlackRock. “It’s understandable because it’s not entirely clear that this is definitely included.”
For the past few days, investors have focused on German giant Deutsche Bank (DBKGn.DE). The company’s shares are down around a quarter of their value this month, including Friday’s 8.5% drop, and the cost of protecting against a default on its bonds has skyrocketed, though few are using it in classify with Credit Suisse.
“We are not concerned today about counterparty and liquidity issues” at Deutsche, analysts at JPMorgan said in a report on Friday.
For now, few investors see this year’s events as a repeat of the systemic crisis that swept through markets in 2008, taking down Lehman Brothers and triggering government bailouts of major financial institutions. But investors are cautious, fearing another bank run could erupt if people think US or European regulators won’t protect depositors.
“It’s almost like the prisoner’s dilemma, where everything should be fine if everyone agrees they don’t withdraw their deposits, but if just one person decides they can get out, the snowball just keeps growing,” said Tim Murray, capital markets strategist in T. Rowe Price’s multi-asset division, which is underweight equities and focuses on money market accounts that offer Treasury-like returns.
Uncertainty about the Fed’s intentions is fueling investor hesitancy in equities and triggering huge swings in US Treasury prices.
The Fed hiked rates 25 basis points on Wednesday but indicated it was close to suspending further hikes. Investors flocked to safe haven US Treasuries, sending two-year bond yields, which accurately reflect the Fed’s policy expectations, to 3.76% this week, the lowest since mid-September.
Further banking industry failures could mean earlier rate cuts as weakening financial conditions allow the Fed to ease its fight against inflation, said Tony Rodriguez, head of fixed income strategy at Nuveen. Futures contracts suggest the Fed will start cutting rates by the end of the year.
Falling interest rates would make dividend stocks and some riskier assets, such as higher-quality below-investment-grade bonds, attractive, Rodriguez said. “It makes sense to take risks in these areas to take advantage of the weakness we’re seeing now.”
Risk assets have had some resilience despite concerns in the banking sector, said Jason England, global bond portfolio manager at Janus Henderson Investors. The S&P 500 is up 3.4% this year, though a long way off its early February highs, and is up 1% this week, helped by a rally in tech stocks.
“When inflation comes down because of disruptions in the banks and you tighten for homeowners, suddenly the Fed has done its job for that,” he said.
The UK expects longer duration bond yields to start rising from current levels, making short-dated bonds and money market funds more attractive.
Investors will likely remain braced for the potential of another high-profile failure until the Fed or Treasury responds in a way that allays fears of another bank run, said Katie Nixon, chief investment officer, wealth management, at Northern Trust, which focuses on stocks in the technology sector with “fortress” balance sheets.
“Right now it’s a crisis of confidence and everyone is looking for direction,” she said.
reporting by David Randall; Adaptation by Leslie Adler
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