Analysis of Recent Market Events
The past week in financial markets has been action packed, to say the least. We hope this post can help you understand what just happened and what it may mean for your portfolio.
Let’s start with the consensus view as of market close March 8, 2023, or roughly one week ago. Preliminary reports indicated that February US economic conditions were still very strong, with the implication that inflation was still much too high. Fed Chair Powell had just given his address before Congress, implying that they may need to go back to doing 50 basis point (bp) rate hikes to stem inflation. The market was forecasting peak interest rates from the Federal Reserve at 5.7% with year-end 2023 rates at roughly 5.6%. In short, investors thought US and global economic conditions were almost too good and were thus very worried that high inflation was here to stay.
Fast forward to today. The market is now forecasting year-end 2023 rates of roughly 4.0% (down almost 2% in one week!) with at most one more 25bp hike left to go before the Fed pauses and then starts reversing course with interest rate cuts.1 We have gone from fears that the economy was still running too hot to concern that the ripple effect of multiple bank failures will ground economic activity to a halt. The Fed has gone from drastically trying to cool the economy to announcing new emergency measures to keep the economy afloat.
What happened to cause this massive shift? Normally we wouldn’t report the day-by-day news like this but given how quickly the environment has changed, we think it is important in this case to help everyone get a full understanding of how things have progressed.
- March 1: Silvergate Bank says that it won’t file its annual 10-K report on time, citing worries about its ability to continue as a going concern. Silvergate had been decimated in 2022 from the collapse of FTX and cryptocurrency in general. Therefore, when Silvergate announced a plan to wind down operations and liquidate on March 8, this was not a surprise and there was no indication that any other firm would be affected.
- March 6: KeyBank cuts its 2023 net interest income guidance, citing pressure in deposit pricing (i.e., they were being forced to raise deposit rates to prevent customers from moving accounts). This is the event that started the recent sell off in regional bank share prices, though losses were still very modest at this point. In fact, most other banks presenting at the same industry conference as KeyBank indicated that everything was still status quo and tracking in line with their most recent earnings guidance from January.
- March 8: Silicon Valley Bank announces plans to raise capital after deposit outflows forced it to sell $21 billion of its securities portfolio, recognizing a loss of $1.8 billion.
- March 9: Reports that major venture capital firms are advising portfolio companies to pull money as quickly as possible from Silicon Valley Bank. The bank’s problems are still viewed as being mostly company specific given its concentrated exposure to venture capital and tech startups in California for both deposits and loans, but there is a growing focus on the fact that other banks also have a lot of unrealized losses on their books from buying government bonds back when interest rates were very low (bonds reprice lower as interest rates rise such that their go-forward yield matches the current market yield).
- March 10: The February jobs report comes in a +311k, above the +225k consensus forecast, but on the other hand, wages rose less than expected, hours worked were down, and the separate Household survey only showed a +177k job gain, leading the unemployment rate to tick up from 3.4% to 3.6%. Therefore, the report is viewed as being fairly neutral versus expectations. Regulators shut down Silicon Valley Bank midday following the failure of its capital raise plan and mass run on its deposits. Silicon Valley Bank is the second largest bank failure in US history (behind Washington Mutual in 2008). It remains very unclear at this point what will happen to Silicon Valley Bank clients with deposits in excess of the $250k FDIC insured limit, a number which as of 12/31/22 totaled $151.5 billion.
- March 12: Signature Bank fails, becoming the third bank to collapse in less than a week. Signature Bank’s concentrated exposure to cryptocurrency firms (20%+ of deposits) appears to have been the driving force behind its collapse, with its geographic concentration in New York (65% of deposits) potentially speeding withdrawals as word spread quickly. The Federal Reserve announces that all Silicon Valley Bank and Signature Bank depositors will have access to their funds on Monday (including uninsured deposits). The Federal Reserve also announces the creation of a new facility, the Bank Term Funding Program (BTFP), that will allow firms to get one-year loans from the Fed by pledging qualifying securities as collateral. Importantly, this collateral will be valued at par, meaning that all the unrealized government bond losses sitting on bank balance sheets can temporarily be ignored if they use this facility.
- March 13: Regional bank stocks continue to be sold aggressively as it becomes clear that while all depositors will be made whole by the Fed in the result of a bank failure, the shareholders will likely be wiped out. Even with the new BTFP facility, no bank can survive a panicked mass run on its deposits and the question becomes what bank will be next? The latest New York Fed survey shows a drop in one-year inflation expectations from 5.0% to 4.2%, potentially relieving some pressure on the Fed to keep interest rates high.2
- March 14: The Consumer Price Index (CPI) for February prints at +6.0% Y/Y, down from +6.4% in January and in line with expectations.3 Shelter costs continue to dominate the rise in the index, but most analysts consider this to be a lagging number as more recent reports on housing and rents suggest a decline. Overall, the report is viewed as fairly neutral and should allow the Fed to pivot and stop raising rates soon given the recent bank failures. Numerous reports of corporate insiders at regional banks buying shares in a show of confidence. Credit card master trust data shows delinquencies and net charge offs continue to rise modestly off their recent abnormally low levels.
- March 15: The Saudi National Commercial Bank, the largest shareholder in Credit Suisse, said it could not provide any more capital to the firm for regulatory reasons. Reports also that UBS (Credit Suisse’s main banking competitor in Switzerland) was seeing major deposit inflows (presumably from Credit Suisse). Later in the day, Credit Suisse announces it will borrow CHF 50 billion (about $54 billion) from the Swiss National Bank to support its core business. First Republic Bank bond rating cut to junk by S&P and Fitch. These headlines pressured Eurozone and US banks once again. The February Producer Price Index (PPI) comes in below expectations at +4.6% Y/Y, down from +5.7% in January.4 This, along with weak Empire Manufacturing and Retail Sales reports, provide the Fed more cover to stop raising rates significantly from here.
- March 16: Mixed economic data as the Philadelphia Fed survey for March comes in very weak, particularly on prices paid (bad news for growth, good news for inflation), while weekly jobless claims fall signaling continued strength in the US jobs market. The European Central Bank (ECB) hikes interest rates 50bp as expected to continue to fight inflation despite the ongoing banking issues.
Is the trouble at Credit Suisse and the failures of Silvergate Bank, Silicon Valley Bank, and Signature Bank due to company-specific issues, or does it have broader implications?
We think both. All of these companies had major company-specific issues and balance sheet mismanagement, most notably (for the US banks) significant concentration risks, allowing for a concern that existed only in one industry or geographic area to threaten their viability. Credit Suisse is more diversified, but it is not surprising that they are in focus given the bank has been in perpetual turnaround-mode since the 2008 crisis, with its share price falling roughly 90% since March 2009 vs. the S&P 500 Financials Index up +470%.
The unrealized losses on bank balance sheets from bond holdings purchased when interest rates were still very low is an industry-wide concern, but the Fed has now given banks a lifeline on this front from the BTFP facility and the drop in interest rates over the past week actually helps alleviate this problem. Unlike in 2008 or most past banking crises, there is little concern about credit risk in loan books at this point as the economy and housing markets remain solid, apart from niche areas like cryptocurrency and Tech startup exposure. Post-2008 US banking reforms including more capital, high-quality capital, and annual stress testing should help stem contagion, but regional banks were subject to less stringent regulations than those deemed globally systemic (something that will likely change going forward as a result of this).
Banks rely on confidence and trust from the public in order to function. No bank (without help from the Fed) can survive a massive run on its deposits. While the facts above point to a limited broader issue, and certainly nothing close to 2008, the risk remains that panicky depositors will force more banks (likely those with unique risk situations) to close before this is done. This may be happening with First Republic Bank right now, which has a more diversified business than Silvergate, Silicon Valley or Signature, but also has concentration risks and, perhaps most critically, has a low cash and market-price securities buffer relative to other banks.
This situation remains fluid and ongoing, and we will remain diligent in incorporating the latest news into our individual stock analyses and portfolio management.
Stay the Course, Stay Diversified
History has repeatedly shown that it is a mistake to divest equities out of fear after markets have seen a large jump in volatility. We continue to recommend staying the course and keeping a long-term focus. We do not believe anything that has happened in the past week represents a long-term risk for our clients’ investments, and we continue to monitor client positions and portfolios daily to ensure they are performing as expected in this environment. This episode again shows the value of having a diversified portfolio, as many areas of the market have remained strong despite the damage inflicted to the Financials sector. We believe GGS client portfolios continue to be well-positioned to weather the current situation and perform well long term.
If you would like further information on any of the topics discussed, please contact your GGS Advisor or the GGS Client Service Team.