Tuesday, May 31, 2022

Guest Post: 2nd Quarter 2022 Financial Markets and Economic Update by Dorothy Jaworski and Sam Weller

Spring Storms

So far, 2022 has brought one storm after another.  Winter storms became spring storms.  Longer-term rates rose very dramatically as Federal Reserve tightening and decades-high inflation converged.  Supply chain issues are the main culprit behind the huge inflation, and only now is demand beginning to fall to more normal levels.  The Russian-Ukraine conflict and resulting sanctions will exacerbate supply chain issues, especially for food and fuel.  Covid-19 lockdowns in China have cut production of goods and ships are again lined up off the coast of China, meaning long delays in getting products to the US.  Stock markets hit new highs in January and quickly began a long and painful sell-off that has continued into May. 

Bond and stock prices falling together for a sustained period of time is very unusual.  What’s even more unusual is that GDP fell -1.4% in 1Q 2022, showing economic weakness right as the Fed begins its tightening campaign.  Consumers, facing inflation pressures, may cut back on spending on discretionary items.  High mortgage rates will begin to affect the housing markets.  We will face challenges as we move forward:  with interest rates- how high is high, and with stocks- how low is low?

I’m very happy to introduce our guest writer for this quarter.  Sam Weller joined us in November, 2021 and has a strong financial background.  I’m sure you’ll enjoy his insights on the markets and the economy as much as I have.  Take it away, Sam...Dorothy

Sam’s Update

Movie fans are excited to see Tom Cruise fly back onto screens this summer with Top Gun: Maverick, a sequel that comes thirty-six years after the original 1986 blockbuster.  At the time the first Top Gun was released, the average cost of a movie ticket was $3.71, milk was $1.09 per gallon and a gallon of gas was only $0.86. Inflation was less than 2.00% and annual GDP was growing at a healthy 4.2%. Interest rates, however, were much higher – the Fed Funds overnight rate was 6.80%, compared to .80% today. But although interest rates above 4.00% seem like a historical anomaly in today’s low rate environment, the Fed Funds rate in 1986 was significantly lower than it was only a few years below, when Paul Volcker’s Federal Reserve used a series of increases in short-term rates to over 20% as its primary tool to “break the back” of inflation.  While we would not expect today’s rates to get anywhere near those levels, the adjustment of rates from zero to 2% and 3% in a short time period is a large move.

Q1 2022 inflation measured 8.5%, the highest single quarter of inflation growth rate seen since a rate of 8.9% in Q4 1980. Does our current Federal Reserve have the same will to fight inflation that Volcker had in the early 1980s?  Clearly, there is ample room to raise interest rates, and the Federal Reserve has been vocal about their willingness to do so.  They are in a difficult position; although desperate to tame spiking inflation, they begin a cycle of tightening rates in an economy that seems to be shrinking, not growing, which should limit the extent to which they can raise rates.

The first half of 2022 has been marked by extreme volatility.  The 10-year US Treasury ended 2021 at a yield of 1.51%.  As of mid-May 2022, it is currently hovering around the 3.00% mark. At the end of 2021, the 2-year US Treasury was yielding .73% and is currently yielding 2.33% as of mid-May.  Bond investors have priced in a substantial increase to inflationary expectations as they discount both long- and short-ends of the yield curve.

This volatility has not been contained to the bond market; the Dow Jones Industrial Average has shed over 4,000 points, or -11%, since the beginning of 2022, while the S&P 500 return is down -15.6% for the year.  However, all the volatility must be good for some asset classes, correct?  Perhaps a long-term store of value, uncorrelated to the broader markets – something like gold, perhaps, or some of the more stable cryptocurrencies?  Gold prices have remained remarkably…unchanged, beginning the year at $1,829 per oz; as of mid-May gold prices were hovering around $1,850.  However, cryptocurrencies have not fared as well: Bitcoin (BTC) began the year at $47,000+ and has plunged to less than $32,000 per BTC as of mid-May.

Most investors believe that we are in a period of “risk off,” with both equity and fixed income markets uncharacteristically moving in tandem as market participants seem to be selling off both bonds and stocks.


Real GDP

The first quarter of 2022 was marked by GDP growth of -1.4%, which was the first non-pandemic related negative GDP growth rate since 2014.  However, after a strong Q4 2021, where real GDP grew +6.9%, this negative growth rate may be a sign of things to come.  In retrospect, examining the high Q4 2021 growth rate shows some potential cracks in the positive fa├žade; 5.0% of the total in Q4 came from growing inventories, and many consumers were already reducing consumption as the effect of monetary stimulus spending during the pandemic began to abate.

Perhaps because of supply chain constraints and inventory challenges, the consumer confidence index remains extremely low going into Q2 2022.  Volatility is high, consumer confidence is low, and it’s very possible that we may see more negative GDP numbers before 2022 is out.



For the first time in over forty years, investors are looking at the prospect of inflation as a serious threat to future earnings.  The Consumer Price Index, or “CPI,” started 2021 at +1.4% to +1.7%, rose to +5.4% by mid-year, and ended December at +7.3%.  In January, 2022, it rose again to +7.5%, and in March, showed the highest annual inflation increase since 1980 at 8.5%.

For most American consumers, the timing of these inflationary pressures could not come at a worse time: after two years of pandemic-related isolation, many corporate managers (and their landlords!) are serious about getting workers back to the office.  With COVID seemingly receding into the background as an endemic health threat, case rates are dropping in many locations across the country.  The only obstacle to getting workers back in person may be the eye-watering sticker shock of funding the commuter lifestyle.

Consider the cost of a Starbucks Venti Frappuccino: now retailing at $5.25 in most locations, the cost of this massive coffee drink is up $0.50 since the beginning of the pandemic, or an increase of over 10%.  Think that’s bad?  Another commuter necessity – gasoline – hovered at around $2.50 per gallon pre-pandemic while today most drivers aren’t filling up their tank for less than $4.50 per gallon on a good day. Interestingly, although refined gasoline at the pump has commuters screaming “price gouging,” the underlying cost of a barrel of crude oil has steadily risen, from $58 a year ago to $110 today.

The Fed started out by saying inflation was “transitory” but had to admit later it was “persistent.”  Now we will see if the Fed can keep it from becoming “sustained,” which means preventing wage inflation from tight labor markets from filtering into the prices of all goods and services. 


The Fed’s Great Expectations

May, 2022 saw the Federal Reserve hike the core Fed Funds overnight rate by fifty basis points, the highest single-meeting rate hike in over two decades.  According to the pricing of the Fed Funds Futures market, the Fed still has a long way to go; traders believe that another 50-basis point rate hike is all but certain in both June and July.  Assuming that’s the case, this summer we will see the Fed Funds overnight target rate at 2.00%, while on our way to the end of our nearly decade long historically low interest rates.

What will the market look like with short-term rates in the 2.00% range?  We know what the Fed hopes will happen: a normalizing of the yield curve, with short-term rates in the 2s and longer-term rates rearranging themselves into a positively sloped yield curve shape that indicates continuing economic strength.  The only problem is, the long end of the curve does not seem to be getting the message yet.  The 10-year US Treasury is currently yielding 2.91% and the 20-year isn’t far behind with a yield of 3.32%.  Clearly investors believe that inflation is a longer-term threat than the Fed would like to believe.

The long-end of the curve has responded first to the Fed’s tightening.  Remember that the 10-year bond is up nearly 150 basis points since the beginning of 2022. However, have long rates gone as high as they can go?  If so, continued Fed tightening will result in the same phenomenon we’ve seen time and again during our historic low rate environment: a flat (or inverted) curve, where investors do not see any appreciable yield pick-up from going out into the longer end of the yield curve.  An inverted yield curve can be a precursor to recessionary conditions.

This is the scenario that the Fed hopes it can avoid.  Raising interest rates at what looks like the outset of a recessionary cycle is a risky move, but rampant inflation has forced the Fed’s hand into raising short-term rates, stopping their bond purchases and reducing the size of their balance sheet. As consumers, we can only hope that it does not tip the scales into additional quarters of negative GDP growth.  After two decades of sedate rate movements and moderate growth, suddenly it’s an exciting market – maybe too exciting.  As they say on the trading floor:  don’t be in a hurry to catch a falling knife. Be careful out there!


Sam Weller


Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

She also was our guest on my firm's January 2022 podcast, This Month in Banking. To listen to that episode on interest rates and the economy, click here or go to wherever you get your podcasts.

Sam Weller has worked as a banker and consultant to community banks for over 20 years. His career has focused on how banks use capital markets strategies to manage risk and enhance earnings. Sam joined Penn Community Bank in November 2021 and manages the Bank's investment portfolio, as well as contributing to asset-liability analysis, hedging, and other Treasury functions. He holds an MBA from the University of Texas and is a graduate of the U.S. Military Academy at West Point.

Friday, May 27, 2022

Memorial Day: Remember Captain Andy Haldane

Peleliu–an island just six miles long and two miles wide–was held by a garrison of more than 10,000 Japanese troops in 1944. The island’s airfield would allow Japanese planes to threaten any Allied operation in the Philippines, and General Douglas MacArthur pushed for an amphibious attack in order to neutralize this threat. 

Admiral William Halsey reported that enemy resistance in the region was far less than expected; he recommended that the landings in the Palaus be canceled entirely and MacArthur’s invasion of Leyte Gulf (in the Philippines) be moved up to October. MacArthur and Admiral Chester Nimitz followed Halsey’s advice about Leyte, but chose to go ahead with the attack on Peleliu.

On September 15, 1944, U.S. Marines landed on the western Pacific Island. Over the next several weeks, ferocious Japanese resistance inflicted heavy casualties on U.S. troops before the Americans were finally able to secure the island. The controversial attack resulted in the highest death toll than any other amphibious assault in U.S. military history. Approximately 40% of the 28,000 Marines and soldiers that saw action on Peleliu were killed or wounded.

Landing on Peleliu with his fellow Marines was Captain Andrew Haldane, the 27 year old Company K Commander of the 1st Marine Division. Haldane  hailed from Methuen Massachusetts.

Captain Haldane was already a chiseled veteran, having served with distinction on Guadalcanal and Cape Gloucester (New Britain, now Papua New Guinea), where he received his first Silver Star for leading Company K and repelling five Japanese bayonet attacks.

On October 12th Company K was engaged in a fierce battle with enemy troops to take Hill 140. They were holding their line but were pinned down and low in their trenches to avoid enemy sniper fire. This rendered their mortars and machine gun fire ineffective because there was nobody directing the fire, an unacceptable situation to Captain Haldane. He would not ask his men to do something he would not do himself. So he raised his head to gain bearings to pass to machine gunners. At that moment he gave his last full measure of devotion and was killed by an enemy sniper. It was three days before Company K was scheduled to be relieved.

The gruesome details of Haldane’s death were described by mortarman Romus Bergin in Islands of the Damned-Marines at War in the Pacific. The description is too graphic for me to repeat to you. Death in battle is not a Hollywood movie.

For Haldane’s actions, he was awarded a posthumous Silver Star that stated:

"The President of the United States of America takes pride in presenting a Gold Star in lieu of a Second Award of the Silver Star (Posthumously) to Captain Andrew A. Haldane (MCSN: 0-8740), United States Marine Corps Reserve, for conspicuous gallantry and intrepidity as Commanding Officer of Company K, Third Battalion, Fifth Marines, FIRST Marine Division in action against enemy Japanese forces on Peleliu and Ngesebus Islands, Palau Group from 15 September to 12 October 1944. A splendid and fearless leader, Captain Haldane repeatedly led his assault company through intense hostile artillery and small arms fire to rout the enemy from strongly held positions with heavy losses. On 12 October, he personally directed a platoon of his men against a firmly defended cave on an important ridge continuing his heroic efforts until mortally wounded by Japanese sniper fire. By his inspiring courage and disregard for personal safety, Captain Haldane contributed materially to the success of our forces in these strategic areas and his valiant conduct throughout was in keeping with the highest traditions of the United States Naval Service. He gallantly gave his life for his country."

Another Company K mortarman, E.B. Sledge (Sledgehammer), described his company commander as follows:

“Capt. Andy Haldane wasn’t an idol. He was human. But he commanded our individual destinies under the most trying conditions with the utmost compassion. We knew he could never be replaced. He was the finest Marine officer I ever knew. The loss of many close friends grieved me deeply on Peleliu and Okinawa. But to all of us the loss of our company commander at Peleliu was like losing a parent we depended on for security-not our physical security, because we knew that was a commodity beyond our reach in combat, but our mental security.”

~ from With The Old Breed by E.B. Sledge

While you are enjoying Memorial Day Weekend with family and friends, I ask you to remember Andy Haldane and all of his comrades that gave their last full measure of devotion on the inglorious rock called Peleliu.

~ Jeff

Note: I encourage you to watch the 2010 HBO Series The Pacific. Produced by Tom Hanks and Steven Spielberg, and narrated by Hanks. It graphically details the exploits of the 1st Marine Division in the Pacific theater during WWII. It may make you uncomfortable. 



Battle of Peleliu - HISTORY

Andrew Haldane - Wikipedia

Amazon.com: With the Old Breed: At Peleliu and Okinawa eBook : Sledge, E.B.: Kindle Store

Islands of the Damned: A Marine at War in the Pacific: Burgin, R.V., Marvel, Bill: 9780451232267: Books - Amazon

Andrew Haldane - Recipient - (militarytimes.com)

Saturday, May 21, 2022

Bank Shareholder Succession Matters

I'm growing more concerned about the time and effort by community financial institutions to understand the needs of next generation shareholders and build a strategy around shareholder succession.

I recently met with a former partner at Wellington Management. You may be aware that Wellington is a significant institutional investor in community bank stocks. I wanted to know from him what he thought community banks should do about shareholder succession. Prior to this post I sent the below summary to our thinly traded clients, and I suspect it might be useful to you. Hope it helps.


Here is a summary of our conversation, with my comments/ ideas in red.

  1. Hold regular meetings with local wealth managers to generate interest for them to invest their client’s money in your local bank stock. Emphasize that the dividend yield is superior to bonds in many respects (if true) and your bank is more transparent than large banks because the wealth managers can see what you are doing in your communities. (Cocktail hours: Make them feel special. Although any information you give them you would likely have to publicly post.)


  1. Offer prizes to shareholders. Use a barcode with your annual report. When they scan you capture their name and how many shares they own and their e-mail. And send them some prize. Keep in mind you might have to do this annually, so perhaps set a minimum of share ownership after year 1 for them to get the prize. This way you have a list of your actual shareholders, including street name, to send periodic information to. (This is to keep an accurate and up-to-date list of your shareholders with contact information so you can maintain consistent communication. Probably should check with SEC counsel first.)


  1. Non-Financial: Tell the stories of how you are meaningful to the community and that it does matter that you are part of the community(s). (Give them that feel-good feeling of owning a local stock.)


  1. Actually calculate the jobs supported through local lending. Many of us did this for PPP, but did we leverage it well and can we do more of it with our traditional lending. (Can this be executed by having the number of employees of a prospective borrower in the write-up that can be tabulated to tell the story? This might be the same for large bank lending, but my guess is that they are not counting the number of jobs supported in your markets by lending to businesses in them.)


  1. Much like we expect our lenders and branch managers to consistently build relationships with customers, consistently build relationships with bank trading shops (including friendly institutional investors) so when shareholder xx passes and the estate has 10k shares, you have multiple people to call. This is beyond going to the institutional investor road shows. This is having people with interest in your stock that you can call when large blocks become available. You know each other by name.


  1. Create your own institutional investor: Consider an ESOP. A built-in friendly institutional investor that can purchase blocks of shares that come available and provide a valuable employee benefit that aligns employees with shareholders.


  1. Dividends- Emphasize to your shareholders how much in income per year the investment generates (if true) so they think of that investment as an income generator rather than a thinly traded bank stock that they might rather deploy in cryptocurrency. Emphasize how long you’ve paid the dividend and growth rate.


  1. Why is marketing un-involved or only tangentially involved with what appears to be a marketing function? Marketing follows regulation in advertising so the skill set of complying with SEC rules should be an easy transition.

9. Make shareholder meeting an event. Perhaps a "state of the community" presentation (who else does this?) that accompanies a "state of the bank." An exclusive event that perhaps non-shareholder would feel they wanted to attend.

What ideas do you have?

~ Jeff