March 2023 | Equity Commentary
Published on April 11th, 2023
March’s financial news cycle was dominated by the high-profile failures of Silicon Valley Bank and Signature Bank New York on March 10, spanning through to March 19 when UBS announced it was buying beleaguered Credit Suisse for $3.2 billion in a deal brokered by Swiss authorities.1 Apart from pronounced selling pressure across a handful of regional bank stocks, the equity markets were largely resilient to rising uncertainty over the health of the banking system. The S&P 500 and Nasdaq posted three consecutive weeks of gains beginning March 13, finishing the first quarter up +7.5% and +17.0%, respectively.2, Outperformance of growth and technology stocks may have been a wager that the banking crisis would hinder economic growth later in the year, thereby raising the chances of easier monetary policy sooner than previously expected. In the fixed income markets, US Treasury bonds across nearly all durations rallied for the month, with the 10-year bond yield declining from 3.92% to 3.47%.3 The 2-year Treasury pulled back in the months’ final days to finish above 4%, which further widened the yield curve inversion.4
Historically, bank failures tend to be driven by credit risk, but Silicon Valley Bank (SVB) and Signature Bank New York (SBNY) were unique cases where large bases of undiversified, uninsured deposit liabilities were mismatched with fixed rate securities that had fallen in value as interest rates rose – eroding the banks’ capital. SVB and SBNY ran into major problems in 2022 when the venture capital/startup world saw funding evaporate and the cryptocurrency industry suffered major setbacks. This led many early-stage companies (clients of SVB) and crypto firms (clients of SBNY) to draw down cash reserves to continue funding operations, which eventually spiraled into a run-on deposits once the banks’ balance sheet problems were exposed.5
Credit Suisse’s forced sale a week later made it seem like a global bank contagion could be underway, but the Swiss lender had already been troubled for months if not years. The bank arguably collapsed under the weight of unstable management, investment banking losses, and a string of bad bets—including its partnership with now-bankrupt Greensill Capital and a $5 billion loss from the collapse of Archegos Capital Management. Last October, rumors of the banks’ problems on social media led to a major outflow of wealthy clients. In 2022, deposits fell more than 40%, and assets plummeted by 30%.6
In response to the SVB and SBNY failures, the Federal Reserve, U.S. Treasury, and Federal Deposit Insurance Corp. issued a joint statement declaring SVB and SBNY “systemic risks,” which opened the door for making all SVB and SBNY depositors whole—including those with deposits over the FDIC-insured $250,000 limit. The Fed also created a special emergency facility called the Bank Term Funding Program, which allowed banks to use debt securities like long duration US Treasuries as collateral for cash loans for up to a year—giving banks access to liquidity without having to sell securities at a loss.7
By the end of the month, news of a possible banking crisis had largely faded. In our view, tier 1 capital ratios and loan-to-deposit ratios suggest the US banking is very well-capitalized, and we would note that nearly all large banks have the ability to meet withdrawal requests without selling illiquid assets or fixed income assets at losses.8 In fact, many large banks actually benefitted from deposit flows in the weeks following the failures, as clients pulled cash from several regional banks.9 We think the relative stability of the broad US stock market last month underscores the underlying strength of the banking system.
From an economic standpoint, banks outside of the largest 25 account for 40% of all loan activity, and small banks in particular are responsible for 67% of all commercial real estate lending.10 The economic impact—including the possibility of recession—could hinge on changes to loan activity in the coming months. In a statement, Federal Reserve Chairman Jerome Powell acknowledged this possibility: “Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes. It is too soon to determine the extent of these effects, and therefore too soon to tell how monetary policy should respond.“11
Perhaps in recognition of potentially adverse economic impact—as well as the possibility that higher rates could create more losses on bank balance sheets—the central bank limited its rate increase to only 25 basis points at the March 22 meeting. The Fed also released projections for the benchmark fed funds rate to settle around 5.1% by the end of the year, implying one more quarter-point increase this year.12 Prior to the bank failures, we believe the Fed planned to forecast a higher year end rate at this meeting, and it was at least considering an acceleration in the pace of rate increases to 50 basis points.
Data suggests the US economy is moving in the direction the Fed wants, though probably not at the desired pace. Households increased spending by a seasonally adjusted 0.2% month-over-month in February, following a 2% month-over-month increase in January. Looking a bit more closely,13 the Commerce Department reported that spending at stores, online, and in restaurants dropped by 0.4% in February, signaling that consumers were pulling back even before the banking issues emerged.14 Job openings also fell in February, to 9.9 million from January’s 10.6 million. While this is down from the peak of 12 million job openings reached in March 2022, it still marks a sizable gap from the 5.9 million unemployed Americans seeking work.15
The Fed’s preferred core personal consumption-expenditures (PCE) price index rose 4.6% year-over-year in February, down from 4.7% in January. The producer price index also fell 0.1% in February from the prior month, a meaningful signal that price pressures are abating.16 Finally, the Fed also reported that M2 money supply declined by $130 billion in February and -2.4% year-over-year. This marks the fastest rate of decline in M2 since the 1930s, but it’s also true that it follows the historic surge of money supply in the wake of the pandemic. Even still, the sharp decline in M2 should eventually have an anchoring effect on inflation. That may help firm the case for the Fed to conclude its tightening campaign in fairly short order, which could be an important silver lining for investors following the spate of bank failures that brought new risks to the fore in recent weeks.17
2.Bloomberg: SPX Index and Nasdaq 1Q Performance
3.Bloomberg: USGG10YR Feb Mar Monthly Yield
As of March 31, 2023