- A Positive Q1. Volatility in the banking sector rose sharply in March following the collapse of three US regional banks. The ensuing market turbulence was fortunately short-lived, powered by a rising sense of optimism that the Fed may be near the end of its year-long hiking cycle. The S&P 500 index finished the month and the quarter higher. Bond markets posted positive results as well.
- Stress in Banking Sector. Financial distress at a California-based regional bank culminated in the second-largest bank failure in US history, and the largest since the ’07 – ’08 financial crisis. Two other regional banks went into administration as well. Outside the US, troubled lender Credit Suisse was bought out by its rival UBS in a deal brokered by the Swiss authorities.
- Anatomy of the Collapse. Silicon Valley Bank and similar institutions catered to a niche clientele of venture capitalists and young tech start-ups. Fueled by the explosive growth in Silicon Valley, the bank saw its assets quadrupling between 2018 and 2021. SVB held an unusually large portion of customers’ deposits in long-dated Treasurys. The value of the investment portfolio dropped as interest rate rose (bonds’ prices and rates have an inverse relationship). A runoff in deposits forced the sale of securities and realizing the “paper losses” of the bonds. Fears of a bank collapse led to bigger withdrawals to the tune of $42 billion in a single day, turning the panic into a reality.
- Federal Reserve. The Federal Reserve raised rates by a total of 0.50% in the first quarter of 2023, and a total of 4.75% since the commencement of the tightening cycle in March 2022. The effects of higher interest rates are felt across the economy, with interest-rate sensitive sectors like housing and autos the hardest hit. As Covid-induced goods inflation continues to wane, the Fed views the tight labor market as inflation’s last stand.
- Economic Resiliency. Real-time GDP tracking for the first quarter indicates a growth rate of 2.2% annualized, a reasonably strong number. Despite the current momentum, market participants are anticipating a more uneven economic outlook for the months ahead. Higher interest rates and tighter lending standards will restrict access to credit. Manufacturing and services continue to fall. On the other hand, the jobs market remains strong, and US consumers continue to spend.
- Market Outlook. We believe the events leading up to the banking stress were largely isolated and contained, and are unlikely precursors to a cascading wave of bank failures like the market endured in ’08 – ’09. However, it was a sign of yet another unintended consequence of the Federal Reserve’s aggressive rate hike campaign exerting a greater impact on the US economy. For the rest of the year, the state of inflation and the accompanying Fed’s monetary policy, as well as the potential and severity of an economic and earnings recession, remain the primary focus. We continue to monitor market developments, and will act accordingly, on clients’ behalf.
