I was recently speaking with one of my best friends, who is a pilot, about flight turbulence. He said there are two kinds of turbulence: natural turbulence caused by weather (wind) and pilot-induced turbulence, which happens when a pilot makes a mistake.
We are beginning to see some increased turbulence (market volatility), but is it a change to overall maket conditions or is it a few isolated mistakes by companies?
The stocks have been resilient over the past two weeks despite rising US/China trade tensions, increased stock volatility, and regional bank losses. These conditions have pulled the S&P 500 off its record highs, but overall, markets remain high.
There are three instances of market turbulence that I am watching to determine if they are a trend or an isolated event: credit issues, unusually high bank borrowing from the Federal Reserve, and lower-than-normal S&P 500 defensive sector weights.
Credit Issues
Bankruptcies are affecting banks: JPMorgan Chase disclosed on the bank’s quarterly earnings call last Tuesday that it had to take a $170 million write-off in the third quarter due to the bankruptcy of subprime auto lender Tricolor. They also mentioned being affected by First Brands (auto parts) bankruptcy. Their CEO, Jamie Dimon, who is often a pessimist, suggested it could be the beginning of more credit problems to come by saying, “When you see one cockroach, there are probably more,” according to the Wall Street Journal.
Bank Borrowing from the Fed
Strangely, US banks borrowed $8 billion from the Federal Reserve’s Standing Repo Facility (SRF) in the last few days. The SRF is a newer Federal Reserve tool that serves as an emergency backup for banks experiencing liquidity shortfalls. This is the largest daily borrowing from the Fed since the COVID-19 pandemic, excluding the normal end-of-quarter times. This might indicate that some credit tightening is coming due to limited liquidity, which could slow business growth.
Low Defensive Sector Weights
Consumer staples, healthcare, and utilities make up the defensive sector of the S&P 500, which is typically where investors keep holdings because they tend to be more stable during economic downturns. Their percentage of the overall S&P 500 has fallen to an all-time low of 16%. The last time the defensives were at an all-time low was at the peak of the dotcom bubble in March 2000, when defensive sectors represented 17% of the S&P 500.
The recurring theme here is the technology sector, which hit a record high of 35% weighting this month (above the 34% weight in March 2000). I don’t think technology is in a bubble. Still, the stock market’s built-in hedge to weather market volatility is unusually small, which means more stocks are at higher risk of being hurt by a market pullback.
I doubt these things develop into a negative trend. Though I expect a short-term pullback, I feel good about the market in general for the rest of the year and 2026. Yet it does pay to be vigilant. Portfolio-wise, stay active, keep allocations near neutral, and pay attention to who is being affected by credit issues and liquidity. Opportunities are out there if you know where to look.
My friend and I were at the airport watching a small plane land when we were discussing pilot-induced turbulence. The small plane was landing with a little crosswind, but my friend pointed out that the plane was swinging side to side so violently because the pilot was making a series of overcorrections to the wind. It landed with no problems, but the passengers had a bumpier ride than they should have because of their pilot. With your investments, make sure your pilot has a steady hand and a lot of experience in various market scenarios.
Have a blessed week!
Richard Baker
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