Let’s talk about the New Fed in Town: Commercial lending banks.
(Currently working on the jingle for the New Fed in Town game show – will report back.)
The banks with feet on the ground in cities like Cincinnati, Idaho Falls, St. Louis, and other markets.
Here’s the message that was received from the Dallas Fed last week…
We’ve talked about the effects of the Fed and higher interest rates on the economy in terms of slowing spending.
The banks are now stepping up to finish the job that the Fed started more than a year ago…
As reported by the Dallas Fed last week, lending activity across the board has been dropping in 2023.
But the pinch is now being felt across the spectrum of lending, and the acceleration of the decline in loan volume has kicked into high gear after the Silicon Valley Bank failure. After that, financial institutions have turned their attention to surviving the high-interest-rate environment and the risk it brings their balance sheets.
the people with the most to lose – those with less expendable income – have been feeling the pain first.
There’s quite the unfortunate correlation of where the impact is being felt, as the most impacted are going to be the areas where the risk for the bank is at a high.
For example, used cars…
Not only are the number of new loans declining, but the number of repossessions is going up. This tells us that those who previously could secure a loan now fall into a position where they can’t afford it.
But now that the little guy is suffering, the next group to start feeling pain is going to be those in the commercial real estate space…
As you can see, there has been a sharp decrease in nearly all loan types, with the only loans holding steady being in the commercial space…
Well, here’s the kicker… Small, regional banks have MUCH larger exposure to commercial real estate than large, national banks.
And, according to Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management:
“More than 50% of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months when new lending rates are likely to be up by 350 to 450 basis points.”
So the question is – as a counterintuitive contrarian and trusting in technicals – where are the opportunities here? (Outside of just outright shorting banks.)
Well, to sort this out we have to remember that there are three things to look at in a trade:
- Is it fundamentally sound?
- Do the technicals paint a clear picture?
- And what is the sentiment surrounding the trade?
Let’s start with the sentiment, as this is the one people tend to overlook.
And right now, we’re seeing a whole slew of articles with headlines like this:
You have the analysts making recommendations on REITs, and we all know what happens when they all start to pile into one spot. On the first sign of a pull back, they will run for the fences in an attempt to save face.
This is a breeding ground for selling pressure when the table starts to tip…
They are trying to paint a picture right now that everything is fine while we sit in a burning building… You know, like that meme with the dog drinking coffee.
But let’s look at the last key point in that above piece, “industrials, retail, and hotels are solid.” They might have me on the hotels – maybe. But regardless, this claim is banking on consumer spending never slowing down.
And with the idea of a recession still looming ahead, banks are not the only ones that are going to be holding their budgets a bit closer…
Looking at headlines like this, people are becoming optimistic about the commercial real estate market.
So, that covers sentiment. The next layer of a trade is the fundamentals, and this requires a bit of a “big picture” look at the economy.
And as I said, there is still a threat of recession causing consumer spending to start to ease back.
This means lower profits in the retail and industrial space, as supply will need to drop along with it.
Needless to say, the fundamentals in the commercial space are terrible at best.
And with earnings season kicking off in just a few days, we are going to see concrete proof of that as these companies start to report.
It’s likely we’ll see a lot of sugarcoating to lessen the blows, but when you look past the sunshine and rainbows, you’ll likely begin to see that there is a lot of fear in the undertones of these companies.
Now, the last leg of finding a solid trade is going to be my bread and butter – the technicals.
The best way to watch the technicals for the commercial real estate space is with the IShares US Real Estate ETF (IYR):
This ETF is currently trading with a bearish 50- and 200-day moving average,
And when you look at the monthly chart that’s shown here, you’ll see it’s trading below its 20-month moving average.
It’s decidedly in a bear market.
Yet the sentiment you’re hearing is still optimistic. It’s all going to be okay.
In the long term – and we’re talking several years – yeah, it will be. We have an extraordinarily resilient economy, and although some companies rot away, the market as a whole ALWAYS bounces back… eventually.
But “several years” is for retirement investing, and that’s not why you’re here.
We look at a much shorter timeframe, and we are seeing red flags all over the place telling us this could be disastrous.
If you are looking to trade it, you can short the IYR with a target of $70 over the next three-to-four months.
And for a more tactical trading adventure, here are a few stocks that are in the high-risk zone that you might want to keep an eye on:
These are companies that you can expect to see a more drastic drawdown on. But be forewarned – these will be much more volatile and can be easily moved by headlines.
I’ll be tracking these, and when there is a clear development, I’ll cover it on The Long and Short of It. Who knows, if you ask nicely, you may even get a side trade on some of these tickers.
This story is just starting to develop, and we are just past the bleeding edge of it, so it’s best to keep it on your radar so you can strike while the iron is hot – I know I’ll be doing the same.
April 11 2023