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Volume 12, Edition 8 | March 13 – March 17, 2023

Seeing the Forest for the Trees

Doug Walters, CFA
Investors appear to have digested Silicon Valley Bank’s collapse without too much indigestion. Financials have been under a microscope, but it’s time to make sure we can see the forest from the trees.

Contributed by Doug Walters, Max Berkovich, David Lemire, Eh Ka Paw

March madness was not just on the court this week. It was also a wild week for market watchers as investors continued to digest the fallout from the collapse of some banking sector darlings. In the end, the US stock market finished the week in positive territory.

The collapse of Silicon Valley Bank (SIVB) put a spotlight on banks, with market-goers trading in their magnifying glass for a microscope in their scrutiny of the sector. But the extremely close interrogation in some cases did not allow them to see the forest for the trees.

It seems increasingly likely that SIVB and the handful of other failed banks are unique in their mismanagement of the higher rate environment (see Headline of the Week). The media has lazily grouped several companies in headlines that don’t belong together. A case in point is Credit Suisse which was struggling long before the Fed began raising rates. And then there are financial custodians, like Charles Schwab (our primary custodian), who have seen their shares decline dramatically in recent weeks. This has nothing to do with SIVB. Schwab is well capitalized, its assets are predominately FDIC insured, and it does not suffer from the customer concentration that plagued SIVB. For Schwab, higher Treasury yields have caused clients to shift assets away from its lucrative cash products. That eats into Schwab’s profitability, which is a challenge for their management and not a problem for their clientele. Said another way – your assets are safe at Schwab.

As we discuss below, rate increases are painful by design, and additional shoes may drop. But investors need to stay above the fray, and the positive market reaction this week suggests they are doing just that. As we discussed last week, diversification is key to riding out market volatility. Expressing your views in well-designed exchange-traded funds (ETFs) rather than individual stocks is a great first step and can help protect against the single stock risk like what we have witnessed in Silicon Valley Bank.

78.2%

Chance of another 25bps rate increase

All eyes will be on the Fed next week as we find out of recent banking sector turmoil changes their calculus on continuing rate increases.

Headline of the Week

Wall Street loves a turn of phrase…

Higher for longer… Can’t fight the Fed…

…to name two. But the most appropriate at this moment (paraphrased), “the Fed raises rates until something gets broken.” Well, mission accomplished; Silicon Valley Bank, Silvergate, Signature Bank, First Republic, and maybe even Credit Suisse. Now this breakage did come about because of the Fed, but higher rates were a material catalyst that exposed largely hidden (in plain sight) risks.

Before last weekend, headlines were dominated by various economic reports and their impact on the Fed’s rate path. Despite significant rate increases, the economy proved resilient. With this week’s breakage, some new thinking could take hold that sees banks, consumers, and other businesses become more risk averse with ramifications for the broader economy. The Fed’s goal all along was arguably to convince the economy to slow down, to take the foot off the gas. Hopefully, that is the result rather than having the foot slam on the brakes.

The Week Ahead

If the last two weeks have given investors bank-related anxiety, don’t expect that to change, as several major central banks will have to decide on interest rate moves this week. The overall number one seed is the Federal Reserve, but the Cinderella pick to make big noise is the Swiss National Bank.

Top Seed

Chairman Powell and the rest of the Federal Reserve will have a tough matchup. They face two foes, inflation and bank failures, next week.

  • While inflation seems to be on the back burner, at least in this meeting, the central bank will be forced to assess what they broke (see above).
  • Overly optimistic traders are betting that the bank failures and Credit Suisse problem will cause the Federal Reserve to pause the hikes as early as this meeting.
  • Market-implied indicators assign a 78.2% chance of another 0.25% move, but the other 21.8% is a no-hike scenario.

Perennial Contenders

The People’s Bank of China and the Bank of England are always in the mix to make a run at headlines, but this month is not their month.

  • The Bank of England (BOE) signaled it might be done tightening or at least very close to the end.
  • The UK will have a timely inflation print before the Thursday meeting. That should be the deciding factor.
  • The Bank of China (BOC) probably will not do anything with rates but is always looking for ways to juice the economy in other ways.
  • The BOC has had some good economic trends to savor recently, so they may have a pass this time.

The Underdog

Rarely do we pay attention to the Swiss National Bank (SNB), but since they are outside the European Union’s Monetary Union, they do have an independent central bank.

  • The focus will certainly not be on interest rates.
  • Credit Suisse’s (CS) solvency issue forced the bank to dish out a $54 billion emergency fund to backstop the cratering bank.
  • Rumors of what the SNB will face include a break-up of the global bank or a forced merger with another Swiss financial goliath (UBS).
  • This could be the SNB’s “one shining moment,” or this could bust some brackets for the continent.

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