Markets Stay Upbeat Despite Banking Turmoil
Markets weathered banking uncertainty in March remarkably well – bonds and stocks both rose, gold soared on rate-cut bets, and credit traders showed confidence in company balance sheets.
Both the S&P 500 (+3.51%) and Nasdaq (+6.69%) equity indices edged higher in March, with technology stocks counteracting a selloff in the financial sector., The tech-focused Nasdaq had its best quarter since 2020, up 16.77%. Tech stocks have benefited from a tailwind driven by hopes that the Federal Reserve (Fed) is close to pausing its aggressive interest-rate hike campaign. Given expectations of lower rates, bond yields have tumbled (leading to higher bond prices).
A Casualty of Higher Interest Rates
The first few weeks of March were dominated by concerns over the banking system sparked by Silicon Valley Bank(SVB), which primarily serviced startups and venture capital investors.
Low interest rates had driven an influx of deposits at SVB, but as the Fed hiked rates and liquidity dried up, depositors began asking for more withdrawals. A shortfall of available cash liquidity led to a classic bank run, where depositors demanded more withdrawals than available capital.
Liquidity concerns spilled over to lower confidence in smaller regional banks like Signature Bank. SVB and Signature eventually became two of the three biggest banking failures in US history. Separately, Silvergate Bank also shut operations after suffering losses from cryptocurrency industry exposure.
Regulators took control of the failed banks, guaranteed all deposits, and are still closely monitoring the banking sector. As concerns spread to Europe, Swiss regulators engineered a takeover of Credit Suisse by UBS to restore trust in the banking system.
After a crisis, the most pressing question is – is the crisis contained, and will it happen again? A few aspects of the bank failures stand out:
Most banks operate with an asset–liability mismatch, where they take in deposits that can be requested immediately, but they make longer-term loans or investments that expire over lengthier periods. SVB had a massive share of its assets invested in long-term fixed-income securities that dropped heavily in value as the Fed hiked rates. When yields go up, bond prices go down.
If they had been able to hold these securities to maturity, they would not have suffered a loss. However, to meet depositor withdrawals, SVB had to sell a $21 billion portfolio at a loss of $1.8 billion while announcing they needed $2 billion in new capital. This announcement spooked investors and cascaded into a bank run where the bank was unable to meet all the withdrawal requests.
Depending on a large long-term government bond portfolio for liquidity during a rising interest rate cycle was questionable – a top regulator at the Fed blamed bank officials for the collapse, calling SVB a case of poor management.”
The obvious question is – weren’t regulations strengthened and more capital requirements put in place after the 2008 financial crisis?
SVB and banks its size are not subject to the stricter regulatory standards that the nation’s biggest banks must follow. In 2018, lawmakers passed a bill that relaxes regulations for many regional financial institutions, including rules regarding the cash reserves required to guard against shocks.
The nation’s largest banks also have to meet stipulations about how diversified their businesses need to be, which turned out to be an Achilles heel for the startup focused SVB. The “Twitter-led bank run” was exacerbated by venture capitalist investors who told their companies to move money out of SVB. Critics are calling for more speed and transparency in US bank supervision, and we wouldn’t be surprised to see more future regulation.
Another critical difference between SVB and much of the banking system is the level of uninsured deposits. The Federal Deposit Insurance Corp (FDIC) protects insurer deposits up to $250,000, but over 94% of SVB deposits were uninsured at the end of 2022 (as were 93% of Signature Bank deposits). Banks where more deposits are covered under FDIC limits are relatively immune to a bank run. At most banks, around half of deposits are uninsured.
After the failures of SVB and Signature Bank, the government’s decision to guarantee all deposits– including uninsured deposits — should help reduce the chances of further bank runs because of liquidity shortfalls. Please view the attached brochure about the safety and protections of your accounts at Fidelity Investments and NFS.
Given the swift measures taken by regulators, the turmoil in the banking system appears to have had limited impact on US consumers. The big picture view is that US banks are far better capitalized now than during previous crises.
The Fed Adjusts
Meanwhile, the crisis has impacted the course of Fed policy.
Even though earlier in the month, Fed chair Jerome Powell indicated that rates might rise above 5.25%, they abandoned those plans at the FOMC meeting Mar 21-22 and left the target range for the federal funds rate unchanged from the December projections, topping out between 5-5.25%. Any tightening in credit conditions from banks can serve as a substitute for rate hikes.
However, following persistent signs of economic growth and inflation, the Fed decided to raise interest rates another quarter point to demonstrate its commitment to fighting inflation., They are now signaling just one more hike this year in the second quarter, but less easing next year than previously projected.
Traders are once again at odds with Fed projections, expecting the Fed to start cutting rates again this year. The shifts in market expectations reflect the impossibility of predicting the exact path of the economy, inflation, and interest rates.
Keep in mind that the uncertainty in markets is just another instance of the unpredictability we’ve seen in our many decades of money management. The prudent approach remains the same: creating a diversified and sustainable strategy that matches your objectives while maintaining discipline to weather volatile markets. We welcome any questions about your portfolio, markets, and the economy – always happy to hear from you!
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