The next time you hear someone say that they just know what is going to happen next in the markets or to our economy, I want you to think about the past 7 days.
We started the last week with economic data that was surprising to the upside. Certain inflation indicators weren’t declining as quickly as the prior month, job reports were coming in hot, and the Federal Reserve Chairman was extremely hawkish when testifying in DC.
The Fed Terminal Rate rose and the word was out: rates would go higher and stay high for longer. The Fed was now going to raise 50 bps instead of 25 bps. Stocks and bonds both sold off. It started to feel like last year again.
Then, later in the week, it came out that Silicon Valley Bank – the 16th largest bank in the country had failed. Something finally broke. The Fed had raised rates so fast that eventually, we’d see some collateral damage. SVB invested a lot of its deposits in long-term bonds to try to maximize the company’s profits.
But you can’t take short-term deposits that people might withdraw and tie them up in long-term bonds unless those bonds are performing well or you have fresh new deposits to compensate.
Well, those bonds obviously did not perform well. With rates rising faster than at any point in history, SVB (and I’m assuming other banks) took a bath on their bond holdings. And since the tech industry and start-up business were either on hold or going in reverse since tightening monetary policy began, there were not enough new deposits to SVB to make up for the losses.
Hence, the bank failed. Now it didn’t feel like last year anymore. 2008 financial crisis PTSD started to kick in for many over the weekend. It felt worse and many regional banks were at risk this week if the government didn’t step in.
Sunday night, they did. They really had no choice. Customers of SVB will be made whole and will have access to their money right away. But SVB and another bank called Signature Bank will not be bailed out and it will die. They probably deserved to – they didn’t have good risk management in place, and they don’t deserve a handout. The equivalent of what they did would you being too risky in retirement and having a portfolio blow up – leaving you with no income.
We could not live in a world where no one trusted their bank system. That is what we were looking at today if no action was taken. There has also been an emergency line set up to prevent this from happening at other banks. Other banks may fail but people’s money will be safe.
Brokerage houses fall under SIPC account protection. SIPC covers $500,000 per account and brokerages must carry an additional insurance policy beyond their clients’ deposits. For instance, TD Ameritrade has the policy to cover all of their deposits of $500 million over the SIPC limits.
So what’s next in the economy? To my point earlier, it’s anyone’s guess. However, I think it’s fair to assume that the Fed needs to take it easy on rising rates. This was a huge shock to the system. Goldman Sachs released a statement last night that they are expecting no more rate increases at all. The options market is still pricing in a 25 bps bump but we very well could be approaching the top in bonds. Or the bottom – however you want to look at it.
In your portfolio, we saw bonds rally the hardest they have in years on Friday. There was a real flight to safety into US treasury bonds. This is good in a way. Diversification is starting to actually help again.
On the stock front, futures opened up nearly 2% last night and are now down 0.50%. It would have been very ugly this morning if those depositors lost their money. Now, we are looking at the possibility of stocks finding their footing and no longer fearing anymore substantial rate hikes.
Regardless, expect the volatility to continue this week but the good news is that the precedent has been set. Deposits are protected.
This post is an excerpt from a private client newsletter on 3/13/2023.