October 2023 | Equity Commentary

Published on November 11, 2023

Stocks posted their third consecutive month of negative performance in October, with the S&P 500 declining -2.1% for the month.¹ From the late July peak through the end of October, the S&P 500 has fallen -8.6%,¹ which is not technically a correction but, to us could be fairly framed as one. Hamas’s October 7 attack on Israel weighed on sentiment early in the month, and three weeks without a speaker of the U.S. House of Representatives also contributed to uncertainty. However, U.S. economic growth remained quite strong during this period of stock market weakness, and the corporate earnings recession of the last three quarters appears to be over. Looking forward, seasonality may work in the stock market’s favor, with historically positive returns for the November – January period. In the bond markets, the 10-year U.S. Treasury bond yield continued to move higher, rising sharply from 4.57% to 4.93% over the course of October.²

 The U.S. economy accelerated in the third quarter. According to the “advance” estimate from the Bureau of Economic Analysis, U.S. GDP expanded at a 4.9% annual rate in Q3, which marks a significant pickup from Q2’s 2.1% pace. On the positive side, GDP growth was largely driven by consumer spending, underscoring ongoing resilience amid higher prices. Q3 output was also boosted by increases in private inventory investment, government spending, and exports. On the negative side, business spending fell off slightly, and commercial and industrial lending declined. These data points suggest that banks and businesses felt inclined to bolster cash reserves in the quarter.³

A closer look at the U.S. consumer reveals a mixed, but mostly positive picture. On the plus side, monthly payroll growth has averaged 258,000 per month over the past year, with wages steadily pushing higher along the way. In October, employers added 150,000 new jobs and average hourly earnings rose 4.1% year-over-year. A key takeaway here is that wage growth now exceeds inflation, which means real wages are going up for Americans – a factor that’s likely bolstering spending. Indeed, real disposable income rose 3.0% during the first nine months of the year, though higher gasoline prices in Q3 took a small bite out of those gains.⁴  Lastly, U.S. labor productivity rose at 4.7% in the third quarter, the biggest improvement since 2009 (if we exclude the period immediately after COVID shutdowns).⁵

The October jobs report did show signs of labor market cooling, however. Nearly all of the job gains came from just three sectors—healthcare, government, leisure & hospitality—with the rest of the economy effectively seeing no job growth for the month. We’d also note that monthly payroll gains have slowed to 204,000 over the past three months, and the unemployment rate has been slowly but consistently moving higher. It registered at 3.9% in October, up from 3.4% in April.⁴ It is possible that the lower October payrolls figure was negatively impacted by the UAW strike, in which case we’d expect to see those jobs return to the November payrolls figure.⁶

Americans are employed and earning higher wages, but higher net worth and demographics are also arguably contributing to resilient spending. Household net worth rose from $116.7 trillion at the end of 2019 to $154.3 trillion as of the end of Q2 2023, with half of that wealth concentrated in the Baby Boomer demographic.⁷ According to the Census Bureau, 17.7% of the population was 65 or older in 2023, the highest percentage going back to 1920. Boomers tend to have relatively stable and healthy finances that benefit from higher interest rates, and many are also just entering retirement, which is a time for less working and more spending. In 2022, Americans age 65 and older accounted for 22% of total consumer spending, the highest percentage since records began over 50 years ago. It’s also up significantly from the 15% of consumer spending that seniors accounted for in 2010.⁸

Despite the strong jobs market and an ongoing willingness to spend, recent data suggests U.S. consumers felt worse about their economic prospects in October than they did in prior months. The Conference Board’s index of consumer confidence fell to 102.6 in October, marking three months of consecutive declines and returning to levels last seen in late 2022 (which, recall, was a year of rising interest rates and a bear market). Consumer confidence metrics fell across a broad range of categories, spanning consumer outlooks for income, business, and employment. The onset of war in the Middle East and the lack of speakership in the House of Representatives may have contributed to souring sentiment.⁹

The headline personal consumption expenditures (PCE) price index, registered at 3.4% year-over-year in September, consistent with July and August’s readings. On a monthly basis, the headline PCE price index rose 0.4%, which was consistent with August but marks an increase from earlier in the summer. As expected, on November 1 the Federal Reserve held the benchmark fed funds rate steady at a range between 5% and 5.25%. Fed officials have now ‘paused’ rate increases at two consecutive meetings, which marks the longest stretch without a rate increase since they started their tightening campaign in March 2022. The Fed likely considers the downtrend in inflation and higher long-term interest rates as two factors working in the right direction, since the former means their primary objective is being addressed and the latter implies tighter financial conditions looking ahead.¹⁰ We believe this pause may indicate that the odds of the Fed being done with its rate hikes have increased.

Sources

1.Bloomberg: SPX Index TRA Function

2.Bloomberg: USGG10YR Index TRA Function

3.Gross Domestic Product, Third Quarter 2023 (Advance Estimate) _ U.S. Bureau of Economic Analysis (BEA).pdf

4.Employment Situation Summary – 2023 M10 Results.pdf

5.Bloomberg: Q3 2023 Productivity vs History

6.Twitter.com Biancoresearch.pdf

7.Yardeni Research Morning Briefing Trick Or Treat .pdf

8.The U.S. Economy’s Secret Weapon_ Seniors With Money to Spend – WSJ.pdf

9.US Consumer Confidence.pdf

10.Personal Income and Outlays, September 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf

As of October 31, 2023

Third Quarter 2023 | Fixed Income Commentary

Published on October 24th, 2023

Fixed Income markets declined in the third quarter as higher interest rates and wider credit spreads weighed on valuations. The Current Income Portfolio declined 0.1% gross (0.4% net),¹ the Bloomberg Intermediate US Govt/Credit Index declined 0.8%, the Bloomberg Intermediate US Corporate Index declined 1.0%, and the ICE BofA Fixed Rate Preferred Securities Index declined 1.2%.² CIP’s outperformance was primarily driven by its shorter duration relative to these indices as well as its allocation to fixed to floating rate coupon securities.³

During the quarter, 10Y US Treasury yields increased 74 bps to reach the highest level since 2007.⁴ The FOMC hiked interest rates by 25 bps in July, and although the committee chose to pause on additional rate hikes in September, participants raised forecasts for the Federal Funds Rate in 2024 by 50 bps (by predicting fewer interest rate cuts) compared with similar projections that were made in June.⁵ Forecasts for policy rates to be held “higher for longer” were likely driven by recent strong economic growth, given the latest increases in U.S. consumption, as opposed to expectations for higher inflation.⁶ In fact, core measures of inflation have moderated somewhat since this time last year, while real GDP has exceeded expectations, increasing by 2.2% and 2.1% (y/y) in the first and second quarters, respectively.⁵,⁷  In addition to expectations for higher growth, we think some of the increase in longer-term yields may also be attributable to a rise in “term premium”, which can be understood as compensation to bondholders for the uncertainty around future inflation. Term premiums can increase from changes in longer-term trends such as deglobalization, a global shortage of workers due to changing demographics, or inflated federal debt that needs to be financed by printing money, in our view.

Median Dot Plot Projections Increased from the June and September 2023 FOMC Meetings

FOMC Dot Plot Projections as of 06/14/23: Grey line

FOMC Dot Plot Projections as of 09/20/23: Green line 

Median forecasts for the Fed Funds Target Rate (as depicted by the FOMC “Dot Plot”) increased by roughly 50 bps in the 2024 and 2025 period projections, from the June 2023 to the September 2023 Federal Reserve meetings. We believe this “higher for longer” outlook contributed to the recent rise in government yields across the tenors of the yield curve.

We believe credit spread widening also contributed to a moderate decline in fixed income security prices during the third quarter. Factors that drove spreads wider may have included the threat of a U.S. government shutdown and strikes by automobile industry workers, in Hollywood, and at UPS. Concerns over potential pressures building on the consumer from the expected resumption of student loan payments, rising oil prices and depleted excess savings accumulated during the pandemic may also have added to general spread widening.⁸ Finally, geopolitical concerns could have also had a negative impact on credit spreads. Growth is slowing in China and its property development sector and related financial institutions may be overleveraged,⁹ the Ukraine conflict appears locked in a stalemate,¹⁰ prolonging its inflationary impacts on the global economy, and a new conflict in the Middle East may also add risk to the global economic outlook.¹¹

Higher government yields and growing credit risk may also continue to exacerbate challenges in commercial real estate and in the banking sector.¹² Although deposits at the largest U.S. banks appear to have stabilized (average deposits across large U.S. banks fell just 0.4% in the third quarter), the value of banks’ securities portfolios typically declines when government yields rise.¹²,¹³ At present, however, we believe the largest US banks are well capitalized enough to withstand potential further unrealized losses. Many banks are cutting costs and building capital in preparation for the “Basel III Endgame” requirements to be phased in over the next two years.¹⁴ We believe this will result in (among other things) significantly more capital being held on bank balance sheets as a buffer to withstand further material declines in valuations.

Commercial real estate values, particularly in the office and retail sectors, may continue to be stressed as higher capitalization rates, shifts in work from home trends, and increased vacancy rates persist.¹³ In fact, many banks have already begun to work out solutions with some of their stressed borrowers, which we believe could have a slight advantage over those loans that are syndicated out through CMBS and still need to be worked out. Additionally, while rents might be down on office properties this year, in other sectors such as multi-family, rents have increased in many parts of the country.¹⁵ Moreover, the largest U.S. banks have diversified loan portfolios such that the greatest exposure to office properties, for any single issuer, is at most 4% of total loans.¹⁶ Nevertheless, we think banks’ earnings will continue to face pressures, as higher rates are paid out on deposits and on other funding sources (such as borrowing from the Bank Term Funding Program), and tighter regulations and higher capital requirements dampen profitability across the industry.¹³ Ultimately, however, we expect the collective impact of new financial regulatory requirements to be net-positive to the credit quality of large U.S. banks.

Looking forward, we believe it is unclear as to how much higher longer-term yields will factor into the Federal Reserve’s decision to keep tightening at the short end of the yield curve. (Recall that when inflation expectations fall and the policy rate is held constant, the Federal Reserve is still effectively “tightening” monetary policy because “real” interest rates are still rising as a result.)  Also, given the typical lagged impact from monetary policy tightening, it could be a while before the data starts to reflect the Fed’s recent hikes. We think upside risks to the future path of interest rates could include strength in spending and payrolls, while downside risks could include weak global growth.

What we believe will matter most is the overall impact on the consumer, which has been resilient thus far thanks to a robust employment market, excess savings, and strength of late in both home prices and stock prices, in our view. We expect the student loan repayment impact to be concentrated in lower-tier discretionary retail, similar to the reduction in SNAP payments that occurred in February, and we believe Beijing has the means and the will to contain its financial system risks, though economic growth in China may remain sluggish. Government shutdowns (not to be confused with debt ceiling brinksmanship, which we believe introduces more risk to capital markets) typically have very limited economic or market impacts, even when they are prolonged, as may occur in this instance.¹⁷

We continue to position the portfolio defensively with respect to credit risk and potential volatility from changes in interest rates. Our target duration of ~4 years on the corporate bond allocation is unchanged (although many of our existing accounts have a shorter duration on the corporate bond sleeve, which we may look to extend by swapping some shorter maturity securities for those with slightly longer maturities). We also maintain a target mix of fixed and fixed to floating rate coupon securities on the preferred allocation. Lastly, we prefer the largest U.S. banks to the regional U.S. banks due to their diversified deposit base and stricter regulatory requirements already adhered to and planned to increase in the future. We still look to diversify the preferred allocation into various non-financial industry groupings and remain selective within our corporate credit security selection.

Sources:

1.GIPS Composite Preliminary Performance 3Q2023

2.Bloomberg Port: Bloomberg Intermediate US Govt/Credit Index, Bloomberg Intermediate US Corporate Index, ICE BofA Fixed Rate Preferred Securities Index

3.Bloomberg Port: OAS

4.Bloomberg Port: USGG10YR Index

5.Transcript of Chair Powell’s Press Conference September 20 2023.pdf

6.The Fed – September 20, 2023_ FOMC Projections materials, accessible version.pdf

7.Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), Second Quarter 2023 and Comprehensive Update _ U.S. Bureau of Economic Analysis (BEA).pdf

8,U.S. Economy Could Withstand One Shock, but Four at Once_ – WSJ.pdf

9.China Slowdown Means It May Never Overtake US Economy, New Forecast Shows – Bloomberg.pdf

10.Opinion _ Ukraine war analysis shows territory stalemate, economy, refugees – Washington Post.pdf

11.Israel-Hamas War Impact Could Tip Global Economy Into Recession – Bloomberg.pdf

12.Speech by Governor Bowman on financial stability in uncertain times – Federal Reserve Board.pdf

13.Federal Reserve Board – Assets and Liabilities of Commercial Banks in the United States – H.8 – October 06, 2023.pdf

14.FDIC_ Speeches, Statements & Testimonies – 6_22_2023 – Remarks by Chairman Martin J. Gruenberg on the Basel III Endgame at the Peterson Institute for International Economics.pdf

15.Examining Apartment Rent Growth Year-to-Date in Mid-2023 _ RealPage Analytics.pdf

16.JPM_Commercial_Real_Esta_2023-03-23_4367489.pdf

17.Breaching the debt ceiling is not the same as a government shutdown. Its consequences could be dire. _ PIIE.pdf

As of September 30, 2023

September 2023 | Equity Commentary

Published on October 11, 2023

Equity markets behaved in September much like they did in August, with interest rates going up and stocks going down. The yield on the 10-year U.S. Treasury bond rose from 4.11% to 4.57% in September¹, a larger increase than was seen in August and which also resulted in a bigger downdraft for stocks. The S&P 500 fell -4.8% for the month.² Looking at August and September together, 10-year Treasury bond yields rose 61 basis points while stocks fell -6.3%.² Generally speaking, higher yields give investors more choices for pursuing risk-adjusted returns, while also reducing the present value of future profits. Both outcomes tend to be negative for stocks, particularly in the high-valuation and high-growth categories. We believe the upshot in the current environment is that data strongly suggests the key driver of higher yields is better-than-expected economic growth, not higher-than-expected inflation. The latter would indicate that rates are rising for the wrong reasons, and also that the Federal Reserve would have no choice but to keep pushing rates higher in the future (which would create sustained pressure on stocks). It appears with inflation trending lower and the Federal Reserve no longer convinced a recession is necessary for controlling prices, there’s still a good argument for a decline in rates next year.

 Many signs point to strong economic growth in the third quarter. According to the New York Federal Reserve’s August SCE Household Spending Survey, households spent 5.5% more in August 2023 than in the same month last year, and more households reported making one large purchase over the previous four months. Earnings reports and other survey data also indicate that Americans have yet to pull back from spending on experiences, like taking trips, buying concert tickets, or splurging on vacations.³  

We believe US consumers’ willingness to spend is largely tied to ongoing strength in the jobs market. In the week ending September 23, weekly unemployment claims were 204,000, which is a historically low figure and also marks a solid improvement from data over the summer.⁴ Americans are also quitting jobs at a much lower rate than they were last year, with the ‘quits rate’ falling to 2.3% in August from a peak of 3% in April 2022. While it is true that the quits rate historically falls during a recession – as workers cling to their jobs – today it seems more tied to better pay, more flexibility, and a general sense that it may be challenging to get an even better job.⁵

Factory activity in the U.S. also improved in September. S&P Global’s manufacturing PMI for September 2023 was 49.8, which exceeded August’s 47.9 and is very close to returning to expansion territory. Output rose at a marginal pace but was the fastest since May. The Institute for Supply Management (ISM) gave a similar readout for U.S. manufacturing, registering at 49% in September from 47.6% in August, with improvements in New Orders and the Production Index.⁶

In Services – a more important factor in determining total U.S. economic output – S&P Global posted Services PMI at 50.1 in September, which remains in expansionary territory. S&P Global’s report indicated that business activity was largely consistent with August, though new orders fell amid weaker domestic and foreign demand. Companies did continue hiring at a solid pace, however, given strong output expectations looking ahead to 2024.⁶ ISM’s Services PMI looked stronger, registering 53.6% in September and showing solid increases in the Business Activity and New Orders indexes.⁷

While the economy demonstrates fundamental strength, inflation has continued to trend lower. In August, core CPI (which strips out food and energy) was up 0.3% from July and 4.3% year-over-year, a solid improvement from July’s 4.7% print. Importantly, when core CPI is looked at over a 3-month period, it increased at an annual rate of 2.4%, which is a substantial improvement from the 5% annual rate recorded over the previous 3-month stretch. 2.4% is also approaching the Fed’s target for inflation, a positive sign. The Labor Department reported that half of August’s headline increase in consumer prices was due to gasoline, which arguably keeps the Fed from becoming too worried, and supports a ‘pause’ of rate increases at the next meeting.⁸

Looking ahead to Q4, Federal Reserve Chairman Jerome Powell summed up many of the concerns playing out in the headlines, when he said: “It’s the strike, it’s government shutdown, resumption of student loan payments, higher long-term rates, oil price shock.”⁹ While each of these factors in a vacuum would not appear to be much of a concern for the broad U.S. economy, it’s the combination of all four that could serve as a headwind to growth as we approach the end of the year. We concede that these factors could make growth more muted in Q4, but we also believe the strength of the jobs market and the U.S. consumer are likely to continue acting as a neutralizing force, as they have all year. From an investment standpoint, the aforementioned headwinds are widely known and reported, which we think reduces their potential to negatively impact equity markets.

Sources

1.Bloomberg USGG10YR Index

2.Bloomberg SPX TRA Index

3.Americans Are Still Spending Like There’s No Tomorrow – WSJ.pdf

4.DOL Unemployment Insurance Weekly Claims News Report

5.Americans’ Growing Reluctance to Quit Their Jobs, in Five Charts – WSJ.pdf

6.S&P Global US Services PMI

7.September ISM World.pdf

8.U.S. Inflation Accelerated in August as Gasoline Prices Jumped – WSJ.pdf

9.U.S. Economy Could Withstand One Shock, but Four at Once_ – WSJ.pdf

As of September 30, 2023

August 2023 | Equity Commentary

Published on September 21st, 2023

The S&P 500 retreated -1.6% in August, which we would frame as a ‘breather’ following the 20.6% rise through the first seven months of the year.¹ It would be difficult to argue that corporate earnings drove weaker returns – in the second quarter, S&P 500 companies delivered a positive 7.91% surprise in earnings and a 2.07% upside surprise for revenues (with 462 companies reporting). Year-over-year, earnings were down -6.02%, but this figure was 8% better than analysts were expecting at the beginning of earnings season, and it’s also worth noting that aggregate earnings were weighed down by pronounced weakness in the Energy and Materials sectors.² Expectations for future earnings and revenues have been rising, reflecting optimism that Q2 or Q3 2023 could mark the trough of earnings declines in this cycle. The 10-year U.S. Treasury bond yield moved 15 basis points higher in August, but a closer look reveals that intra-month, yields climbed up to 4.34% – the highest level since 2007.³ 

 We think the key story for capital markets in August was the yield curve shifting higher, driven mostly by the 10-year Treasury bond’s 15 basis point move. We believe yields likely rose due to a number of factors. First, the supply of long-term bonds appears to be increasing, which we believe is a byproduct of limited issuance during the debt ceiling standoff combined with rising deficits as big spending programs kick in. We think seasonality is a second factor – August tends to see lighter trading volumes, and lower liquidity levels can exacerbate moves in either direction. We also wrote last month about the Bank of Japan’s surprise move to loosen yield curve controls, which may have shifted some demand away from U.S. Treasuries.

While these are all meaningful factors driving yields higher, we think the important takeaway in August was that upward pressure on yields was likely driven more by growth than inflation – with the latter trending lower while expectations for growth moved upward. Consumer price index (CPI) data for July was relatively benign. The Labor Department reported that core CPI rose by 4.7% year-over-year, a slight cooling from June’s 4.8% annual rate. Month-over-month core CPI also showed signs of cooling, up just 0.2% from June to July. Another, perhaps more insightful look at core inflation is to consider the 3-month annualized rate, which in July came in at 3.1% – the lowest print in two years.⁴

While inflation trends lower, expectations for economic growth are moving in the other direction. As of September 8, the Atlanta Federal Reserve’s GDPNow tracker is projecting the U.S. economy will expand by 5.6% in the third quarter, and consensus that the U.S. is heading for a recession in 2023 has largely dissipated.⁵ It appears that some economists have pushed out recession expectations to 2024, while others have embraced the idea of a soft economic landing. Either way, given that a recession is typically defined by two consecutive quarters of economic contraction, a downturn in 2023 is likely off the table.

U.S. consumers have been powering the better-than-expected economic growth story. In the second quarter, the Consumer Discretionary sector produced +35.43% year-over-year earnings growth on +11.63% higher revenues (also the strongest showing among S&P 500 sectors). While improving revenues were largely expected, the earnings surprise of 21.23% marked a blowout of analyst expectations.⁶ An important driver of strong spending has been real wage growth. Over the past 12 months, average hourly earnings have increased by 4.3%,⁷ while inflation (CPI, including food and energy) has risen by 3.2% over the same period.⁸

A healthy jobs market is helping. August data from the U.S. Labor Department showed the jobs market moving in the direction the Fed wants (slightly weakening), while still remaining in overall strong shape. Nonfarm payrolls rose by 187,000 for the month, with downward revisions to June and July. All told, the three-month moving average increase in employment dropped to 150,000 jobs/month, which is more in-line with pre-pandemic norms.⁹ The number of job openings also fell from 9.16 million in July to 8.8 million in August,¹⁰ while a 736,000 surge in the labor force (0.2% increase) pushed the unemployment rate from 3.5% to 3.8%.⁹   

The Federal Reserve’s annual economic symposium in Jackson Hole took place in August, and in it Chairman Jerome Powell acknowledged that GDP growth “has come in above expectations and above its longer-run trend.” He also pointed to strong consumer spending and the “incomplete rebalancing” of the labor market as possible risks to inflation, which “could warrant further tightening of monetary policy.” Chairman Powell struck a cautious tone, but he also seemed careful not to commit to further rate increases in this cycle. The market seems to think rate hikes are done, pricing-in a less than 50% likelihood of an increase at the next two meetings.¹¹ 

An asterisk to the inflation and interest rate outlook could come in the form of higher crude oil prices. Last week, Brent crude closed above $90/barrel for the first time since November 2022, as OPEC members and Saudi Arabia announced that production cuts would be extended through the end of this year. Saudi Arabia’s production cuts were previously scheduled to end this month. Russia added to expectations for global supply tightness by announcing a reduction in exports through the end of the year.¹² We believe the Fed tends to care more about core inflation figures, which strip out food and energy prices, but inflationary pressure in any form could put pressure on the Fed to respond in some way.

Sources

[1] Bloomberg SPX Index TRA

[2] Bloomberg SPX Index Earnings Suprise.docx

[3] Resource Center _ U.S. Department of the Treasury.pdf

[4] Consumer Price Index News Release – 2023 M07 Results.pdf

[5] GDPNow – FRBA.pdf

[6] Yardeni forward earnings and revenues as of 8-31-23.pdf

[7] August U.S. Jobs Report_ 187,000 Rise in Payrolls, Unemployment Rate Jumps _ Morningstar.pdf

[8] Consumer prices up 3.2 percent from July 2022 to July 2023 _ The Economics Daily_ U.S. Bureau of Labor Statistics.pdf

[9] BLS empsit.pdf

[10] Job Openings and Labor Turnover Summary – 2023 M07 Results.pdf

[11] Highlights of Fed Chair Powell’s Jackson Hole speech _ Reuters.pdf

[12] Bloomberg Brent Oil Hits $90 a Barrel After OPEC+ Extends Supply Curbs.docx

As of August 31, 2023

July 2023 | Equity Commentary

Published on August 16th, 2023

Last month we wrote about the U.S. economy staving off a recession in spite of monetary tightening and broad expectations for a downturn. In July, the Commerce Department confirmed that the U.S. economy continued to grow in the second quarter. The “advance” estimate for annual GDP growth in Q2 2023 was 2.4%, which would mark an acceleration from Q1’s 2.0% rate.¹ The “advance” estimate is subject to revision, but the takeaway remains that the U.S. economy is performing better than expected. We believe economic growth combined with stable activity in the jobs market has shifted market expectations towards a “soft landing,” which arguably contributed to the S&P 500 index’s 3.2% gain in July.² The 10-year U.S. Treasury bond yield also rose 12 basis points in the month, from 3.84% to 3.96%,³ which we would expect to see in response to economic resilience. Looking ahead, history suggests there is a meaningful probability that stocks also perform well in the second half of the year. Since 1970, when the first six months’ return for the S&P 500 was between +10% and +20%, the average second half return was +10.7%, with positive returns 100% of the time.⁴

A majority of S&P 500 companies have now reported Q2 earnings, and the results appear mixed. FactSet reports that 79% of reporting companies (as of August 4) delivered better than expected earnings-per-share (EPS) results, which is higher than both the 5- and 10-year averages. 65% of S&P 500 companies reported beating revenue estimates, which is below the 5-year average of 69% but above the 10-year average of 63%. Overall earnings are expected to decline by roughly 5% year-over-year in Q2, which is the weakest showing for earnings since 2020.⁵

On the bright side, we noted many corporations citing resilient U.S. consumers in their reports. Anecdotally, Amazon posted earnings that were nearly double analysts’ estimates, with a large positive contribution coming from its core e-commerce business.⁶ Consumers also appear to remain enthusiastic about travel this summer, with Airbnb reporting a Q2 profit jump of over 70% from Q2 2022.⁷ Steady consumer spending data squares with data we’ve seen from the University of Michigan and the Conference Board pointing to improving consumer sentiment. The University of Michigan reported that consumer sentiment rose 11% from June, reaching its highest level since October 2021.⁸

Activity in the U.S. services sector also remains reasonably healthy. S&P Global reported that Services PMI was 52.3% for July, which is pretty firmly in expansion territory but does mark a deceleration from June’s 54.4% print. The Institute for Supply Management similarly reported July Services PMI at 52.7%, which was 1.2% lower than June’s 53.9% reading. While services activity has been positive for economic growth, the manufacturing sector has been contracting for several months. S&P Global reported July Manufacturing PMI at 49% while ISM reported 46.4%. The upshot is that manufacturing activity, while still somewhat depressed, appears to be improving—both S&P Global and ISM reported better activity in July than in June.⁹

The Labor Department reported that nonfarm payrolls rose by 187,000 in July, following a revised 185,000 in June. While positive, these figures mark a material slowdown in hiring from last year’s 399,000 new jobs per month pace (on average), and also the 287,000 jobs per month average for the first five months of 2023. Insofar as a slowing pace of hiring reflects a cooling economy, it will factor as positive news for the Federal Reserve and may reduce market expectations for additional rate hikes. Wage pressures remain an issue, however, as private-sector pay increased 4.4% year-over-year in July. This pace of wage gains is not compatible with the Fed’s 2% inflation target.¹⁰

In June, inflation as measured by the core personal consumption expenditures (PCE) price index came in at 4.1% year-over-year. Core prices rose 0.2% from May to June. Price pressures have been easing substantially since last year, but 4.1% is still roughly double the Fed’s target.¹¹ Wage gains factor as a negative in the inflation fight, but positive signs exist elsewhere – the producer price index (PPI), for instance, increased just 0.1% month-over-month in June, and final demand less foods, energy, and trade services was up 2.6% year-over-year.¹²

In the realm of monetary policy, the Federal Reserve raised the benchmark fed funds rate by another 25 basis points at their July meeting, as expected. This move pushed fed funds to a 22-year high, now at a range between 5.25% and 5.5%.¹³ The Fed’s move did not come as a surprise to markets, but other central bank decisions in late July did – and they happened on the same day.

On July 27, the European Central Bank (ECB) raised rates by 25 basis points, as expected. But what surprised markets was an indication that the ECB may be ready to pause hikes for now, which seems premature given still elevated inflation and commodity price volatility considering the region’s proximity to the Russia-Ukraine war. Europe’s labor force is also more unionized than the U.S., which we would argue makes it more vulnerable to a wage-price spiral.¹⁴ The Bank of Japan also surprised markets on the same day by loosening their yield curve controls, which may have contributed to a recent increase in U.S. Treasury yields as investors shifted capital from the U.S. to Japan.¹⁵

Finally, China’s economy continues to show real signs of struggle. Exports fell by -14.5% in July, marking the biggest year-over-year decline since the heart of the pandemic in February 2020. Imports also fell by -12.3% over the same period, indicating that the surge in domestic demand many economists were anticipating (post-zero Covid) has not materialized. And where the rest of the developed world is battling price pressures, China has the opposite problem – CPI in July fell -0.3% year-over-year, with producer prices dropping -4.4% over the same period, according to the National Bureau of Statistics. The government’s response thus far has been relatively toothless, in our view, with no concrete plans for meaningful levels of fiscal stimulus.¹⁶

Source

[1] Gross Domestic Product _ U.S. Bureau of Economic Analysis (BEA).pdf

[2] Bloomberg: SPX Index TRA

[3] Bloomberg: USGG10YR Index TRA

[4] Bloomberg: 1^st Half Returns Analysis

[5] EarningsInsight_080423.pdf

[6] Amazon.com, Inc. – Amazon.com Announces Second Quarter Results.pdf

[7] Airbnb profit jumps to $650 million in 2Q as bookings increase, rental rates hold steady – CBS San Francisco.pdf

[8] Surveys of Consumers.pdf

[9] July 2023 Manufacturing ISM® Report On Business®.pdf

[10] U.S. Economy Added 187,000 Jobs in July in Latest Report – WSJ.pdf

[11] https://www.bea.gov/sites/default/files/2023-07/pi0623.pdf

[12] https://www.bls.gov/news.release/pdf/ppi.pdf

[13] Fed meeting July 2023_ Fed approves hike, interest rates rise to highest level in more than 22 years.pdf

[14] ECB rate decision July 2023_ raises rates by 25 basis points.pdf

[15] Bank of Japan loosen’s YCC, cites ‘greater flexibility’ and jolts markets.pdf

[16] China consumer prices fall first time in 2 years, deflation fears grow.pdf

As of July 31, 2023

Second Quarter 2023 | Fixed Income Commentary

Published on July 27th, 2023

Investor concerns over “sticky” inflation persisted during the second quarter as core measures of the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE), which exclude the more volatile components such as food and energy, continued to come in well above the Federal Reserve’s 2% target. Core CPI increased by 5.5% and 5.3%,¹ and Core PCE increased by 4.7% and 4.6%, for the 12-month periods ending in April and May,² respectively. Despite sustained inflationary pressures, recent macro-economic data have generally surprised to the upside and demonstrated the resiliency of the U.S. economy. First quarter real GDP was revised up from 1.3% to 2.0%,³ consumer confidence reached the highest level since January 2022, and after declining in March,⁴ retail sales gained 0.4% and 0.3% in April and in May,⁵ respectively. Additionally, the labor market remains historically tight⁶ and measures of household wealth are still high.⁷ Overall, the economy appears to be strong, which has driven real yields higher⁸ and contributed to the increase in 2Y and 10Y Treasury yields of 87 bps and 37 bps during the second quarter, respectively.⁹

In response to above-target inflation, a tight labor market and a strong economy, the FOMC raised the Federal Funds Rate by 25 bps in May, for a total of 500 bps of hikes over a 14-month period.¹⁰ Moreover, although the FOMC paused on additional rate hikes in June, the Federal Reserve’s Summary of Economic Projections (released each quarter) revealed forecasts for two additional 25 bps hikes this year, and the chances of a 25 bp hike in July increased to 87% as of quarter end.¹¹

In addition to a resilient U.S. economy, we believe stresses in the banking sector also appear to have moderated in recent months. As mentioned in previous commentary, the banks that failed in March had a significantly higher proportion of uninsured deposits, and less stable deposit bases, than a majority of U.S. banks, in our view. Roughly 88% and 68% of Silicon Valley and First Republic Banks’ deposits were uninsured, and both banks experienced drastic declines in deposits of over 80% and 40%, in the first quarter, respectively. Many of the regional banks we own have over 50% of deposits in account sizes below the $250,000 FDIC insured level, which puts them at lower risk of rapid and extreme deposit loss, in our opinion.¹² Additionally, weekly deposit statistics for U.S. banks have alternated between rising and falling throughout the second quarter, leaving them largely unchanged over the past ten weeks (for the period ending June 28) and demonstrating signs of stabilization. In fact, for the largest U.S. banks, deposits have increased in 26 of the past 30 weeks.¹³ U.S. Banks’ combined borrowings from the Federal Reserve’s discount window and Bank Term Funding Program (BTFP) have also declined from a peak of $165 Billion, just after the failure of Silicon Valley Bank, to $105 Billion as of June 28^th; indicating declining usage of the Federal Reserve’s emergency lending facilities.¹⁴

We have previously highlighted the potential earnings headwinds in the U.S. financial sector from exposure to commercial real estate, and specifically office properties. While we believe that work from home and office vacancy trends may continue, we view the potential threat posed to banks’ earnings and capital as manageable for several reasons:  

1. Total office property commercial real estate exposure for any of the largest U.S. banks we own is at most ~4% of total loans.¹⁵
2. Lease turnover is staggered over multiple years so the impact from lease expirations in multi-tenant properties won’t be felt all at once. Of the $5.6T of commercial real estate held by banks, roughly 20% is backed by office properties, of which it’s estimated that only ~$55-60 billion held on banks’ balance sheets is up for renewal in the next year.¹⁶
3. Declines in property values don’t necessarily prompt loan defaults. Even if “unrealized” losses indicate that loan values are now equal to the re-appraised value of commercial properties, if rental income covers debt service costs, the property will likely remain performing.¹⁷
4. Banks can build reserves for future losses ahead of time, effectively creating a capital buffer for potential losses should they materialize. According to the Federal Reserve’s weekly H.8 report, for the period ending June 28^th, the largest U.S. banks have increased loan loss reserves by over 16% on a year over year basis.¹³ While holding excess reserves can weigh on banks’ earnings and equity prices over the near term, it is supportive from a credit perspective to retain capital for future losses.
5. Losses from commercial real estate ultimately impact banks’ balance sheets through quarterly net charge offs, which occur over consecutive periods, as opposed to all at once. In fact, in the height of the financial crisis, losses from commercial real estate peaked at just 3.27% in the fourth quarter of 2009.¹⁵

As part of an annual check-up on the health of the financial system, the largest U.S. Banks recently passed their 2023 stress tests and demonstrated the ability to handle the following hypothetical adverse economic developments: “The severely adverse scenario is characterized by a severe global recession accompanied by a period of heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets. The U.S. unemployment rate rises nearly 6-1/2 percentage points from the starting point of the scenario in the fourth quarter of 2022 to its peak of 10 percent in the third quarter of 2024. The sharp decline in economic activity is also accompanied by an increase in market volatility, widening corporate bond spreads, and a collapse in asset prices, including a 38 percent decline in house prices and a 40 percent decline in commercial real estate prices.” Further, “Declines in commercial real estate prices should be assumed to be concentrated in properties most at risk of a sustained drop in income and asset values: offices that may be affected by remote work or hospitality sectors that continue to be affected by reduced business travel.”¹⁸ Therefore, according to the 2023 stress test results, the largest U.S. banks can handle a 40% decline in CRE values, concentrated in office properties and accompanied by various other negative variables, while maintaining capital above the respective thresholds and continuing to lend to households and businesses.

In addition to easing pressures in the banking sector, we believe credit conditions in the broader corporate market also appear to have improved. In aggregate, investment grade companies’ profit margins, leverage ratios, cash balances and quick ratios from first quarter earnings results were all better relative to the prior quarter.¹⁹ Although interest coverage levels dropped slightly from the prior quarter, they generally remain at healthy levels, in our opinion. Overall, we believe the sector’s better fundamentals drove investment grade credit spreads to decline by 15 bps throughout the second quarter.²⁰

Consequently, fixed income returns were relatively flat in the second quarter as the impact from higher government yields was largely offset by credit spreads tightening, in our view. CIP returned 0.3% (gross) and 0.01% (net), while the Bloomberg Intermediate US Government Credit Index, the Bloomberg Intermediate US Corporate Index, and the ICE BofA Fixed Rate Preferred Securities Index returned -0.8%, -0.2% and 1.22%, respectively.²¹

Looking ahead, we continue to monitor the portfolio for possible risks in the banking sector relating to deposit flows and asset quality. While we expect potential headwinds to bank earnings over the near term, we do not believe the banks we own to be at similar risk of failure as those that fell in March. Proposals for further regulation on capital and liquidity are already underway for large and mid-sized banks with assets > $100 million,²² which we believe to be credit positive in the long run. We also remain selective with respect to non-financial issuers’ credit quality, as we recognize the potential for credit spreads to widen from their currently tight levels. Even so, we view the overall risk/reward of the current yield environment as attractive from a historical context as today’s all-in corporate bond and preferred securities yields are at some of the highest levels they’ve been in years.²³

Sources:

1. https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm

2. Personal Income and Outlays, May 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf

3. Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), and GDP.pdf

4. US Consumer Confidence.pdf

5. Monthly Retail Trade – Sales Report.pdf

6. Civilian unemployment rate.pdf

7. Households; Total Assets, Level (BOGZ1FL192000005Q) _ FRED _ St. Louis Fed.pdf

8. Bloomberg: GTII10 Govt Index Function

9. Bloomberg USGG10YR Index; USGG2YR Index Function.docx

10. Federal Reserve Board – Federal Reserve issues FOMC statement.pdf

11. fomcprojtabl20230614.pdf

12. Barclays Research and SP Global Market Intelligence.doc

13. h8.pdf

14. h41.pdf

15. Barclays_Bank_Stock_Outlook_Forecasting_and_Valuation-2023 (1).pdf

16. Global_Outlook_The_case_for_US_exceptionalism.pdf

17. Thinking Macro_ Office CRE is a problem, just not a macro one.pdf

18. bcreg20230209a1.pdf

19. Barclays Research

20. Bloomberg: US Agg Credit Avg OAS.docx

21. Portfolio Accounting System of Axys, an Advent Licensed Product

22. Speech by Vice Chair for Supervision Barr on bank capital – Federal Reserve Board.pdf

23. Bloomberg OAS ICE Bofa Fixed Rate Preferred Securities Index YTW US Corp Index YTW .docx

As of June 30, 2023

June 2023 | Equity Commentary

Published on July 11th, 2023

Many economists have spent the past year anticipating a US recession. It did not arrive in the first half of 2023. The Commerce Department reported that real gross domestic product grew at a 2% annualized rate in the first quarter, which marked a significant upward revision from the previous 1.3% estimate. Exports and consumer spending were critical drivers of the additional growth, with the latter receiving continued support from a strong jobs market.¹ Employers have added approximately 1.6 million new jobs so far in 2023, which is nearly double the pace set in 2019² – when the pre-pandemic economy was considered quite strong. In our opinion, economic outcomes in the year’s first half might aptly be described as “not as bad as expected,” which arguably contributed to the strong showing in equity markets. It appears that the regional banking crisis did not produce a broader financial contagion, the debt ceiling standoff ended without default, and higher interest rates have not pushed employment or growth materially lower. Stocks benefited at each turn, with the S&P 500 jumping +6.6% in June and rallying +16.9% over the first six months.³ The 10-year US Treasury bond sold off slightly in June to finish the month at 3.84% but remained mostly flat for the year.⁴    

 The Federal Open Markets Committee voted unanimously at their June meeting to hold the benchmark fed funds rate steady at 5% to 5.25%. Minutes from the meeting suggest that Fed officials largely believe additional rate increases may be needed to tighten policy further.⁵

Inflation has been trending lower but remains well above the Fed’s 2% target. Headline Personal Consumption Expenditure (PCE) inflation was up 4.9% year-over-year in the first quarter, though May’s print broke below the 4% level with a 3.8% annualized increase. Core prices, which exclude food and energy, registered at 4.6% in May, a slight improvement from April’s 4.7% level.⁶ We believe inflation should continue to trend lower in the second half of the year, but the distance between current readings and the Fed’s target suggests at least one or two more rate hikes are likely in 2023.

Contributing to the thesis of additional rate increases is the still-too-strong labor market, with the Labor Department reported employers increased payrolls by an average of 314,000 jobs per month through May. Payrolls do not tell the entire story, however, and other key metrics suggest the jobs market may be slightly weaker than headlines suggest.⁷ While June’s ADP report was an addition of nearly 500,000 jobs, more than double the estimate, the Bureau of Labor Statistics non-farm payrolls number for June was just 209,000, about 10% below consensus and a clear downtick from the average of prior months.⁸  Initial applications for unemployment benefits, a proxy for layoffs, are up approximately 20% this year, albeit from a very low level, and workers are quitting jobs at a much slower rate than last year – suggesting that prospects for better jobs with higher pay may be diminishing. The ‘quits rate’ (measures job separations triggered by the employee) has been trending lower since its peak at 3% in April 2022, but ticked back up to 2.6% in June, the same level where it finished 2022.⁷ 

The Institute for Supply Management’s June report on services and manufacturing activity was mixed, in our opinion. The US services sector remained in expansion mode for the sixth consecutive month, with Services PMI registering at 53.9. Among the strong contributors to services sector activity was the Business Activity Index, which rose 7.7% from May, and the New Orders Index, which increased by 2.6%. On the other hand, manufacturing activity remains weak. The June Manufacturing PMI was 46.0, a nearly 1% drop from May and the seventh straight month of contraction. Notably, the forward-looking new orders index remains firmly in contraction territory, at 45.6, while order backlogs fell and inventories shrank. All of these metrics point to slower demand. One positive to parse from the data was the price index, which fell to its lowest level in 2023. Easing price pressures factor as a positive for inflation and interest rates, and also signal improved supply chain conditions. ⁹

US consumers continue to support economic growth, with retail spending rising a modest 0.1% in May.⁶ When adjusted for inflation, spending was flat, which implies consumers are not tapped out but also not spending at robust levels. Monthly auto sales continue to trend upward as supply chain pressures have eased and helped availability of vehicles, while pent-up demand from recent years supports new car purchasing activity.¹⁰

The Conference Board’s measure of consumer confidence shows that Americans are largely upbeat about economic conditions, with the index rising to 109.7 in June from 102.5 in May.¹¹ Strong jobs and wages  helping, but we may see some pressure build in the fall when federal student-loan borrowers must resume making monthly debt repayments. We expect the market impact to be muted, however, given that student-loan payments are estimated to amount to about $6 billion to $9 billion a month – a small percentage of the $1.5 trillion that US consumers spend on goods and services every month.⁶

Overseas, China’s economy continues to show signs of weakening following an initial post-zero-Covid bump. The key manufacturing sector contracted for a third straight month in June, with a subindex on employment falling to 48.2 in June – a sign of continued stress in the labor market. Demand for Chinese goods is facing domestic and international headwinds, with China’s consumers losing steam and foreign buyers facing high inflation pressures. Political tensions are also weighing on economic prospects, as pressure is mounting on manufacturers and multinational corporations to diversify their supply chains and shift production out of China. Global equity markets would likely cheer a stimulus package from Chinese government officials to boost economic growth in the second half of the year, but it remains unclear whether Beijing will enact any meaningful new measures.¹²

Sources

1. Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), and GDP by Industry, First Quarter 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf

2. Labor Market Headfake_ Key Report Could Be Overestimating Job Growth – WSJ.pdf

3. Bloomberg: SPX Index TRA Function

4. Bloomberg USGG10YR Index

5. Fed rate decision June 2023_ Fed pauses rate hikes, sees two more ahead this year.pdf

6. U.S. Inflation, Consumer Spending Growth Cooled in May – WSJ.pdf

7. Americans Have Quit Quitting Their Jobs – WSJ.pdf

8. Wage Gains, Low Unemployment Keep Pressure on Fed; Hiring Slowed in June, Jobs Report Shows – WSJ.pdf

9. https://www.ismworld.org June manufacturing and services reports

10. U.S. New-Vehicle Sales Rise an Estimated 13% in First Half of the Year – WSJ.pdf

11. US Consumer Confidence Improved Substantially in June.pdf

12. China’s Economy Shows New Signs of Weakness – WSJ.pdf

As of June 30, 2023

May 2023 | Equity Commentary

Published on June 13th, 2023

The debt ceiling debate featured prominently in financial headlines throughout May, but it appeared equity markets seemed far less concerned about default than media commentators. Volatility remained relatively subdued for the month, with the S&P 500 rising for three consecutive weeks to finish up +0.4%.¹ However, we believe the rally lacked breadth—the top five contributors to the S&P 500 (Nvidia, Alphabet, Amazon, Microsoft, and Apple) added 2.4% to the index return for the month, while the remaining 495 companies subtracted -2.0%.²  A similar pattern has played out throughout 2023, with the capitalization-weighted S&P 500 up double-digits for the year but an equal-weighted version of the index roughly flat.³ In bond markets, yields on short-duration Treasury bills rose sharply with debt ceiling uncertainty,⁴ but longer-duration Treasury bonds showed less pressure. The 10-year US Treasury bond yield rose only slightly in May from 3.59% to 3.64%.⁵

 Just a few days before the “X date” of June 5, President Joe Biden and House Speaker Kevin McCarthy reached a deal to suspend the debt ceiling in exchange for spending cuts totaling $1.5 trillion over ten years (according to the Congressional Budget Office). The bill passed with comfortable margins of 314 to 117 in the House and 63 to 36 in the Senate. Among the spending cuts were $20 billion in reduced funding for the IRS and the setting of an official end date to the Biden administration’s pause on student loan repayments. But a close look at the deal shows no meaningful change to the US government’s debt growth trajectory over the next several years, in our opinion. By some estimates, the deal would only reduce federal spending from its current baseline by about 0.2% of GDP over the next two years.⁶

The May US jobs report underscored ongoing strength in the services sector, particularly in transportation, health and education, and leisure and hospitality. Nonfarm payrolls rose by 339,000, well above consensus estimates and up from 225,000 in April. Household survey data showed that the number of unemployed people increased by 440,000 to 6.1 million, which factored into the unemployment rate rising by 0.3% in May to 3.7%.We believe strong momentum in the labor market continues to frustrate the Federal Reserve, but one bright spot in May’s jobs report was slowing wage pressures. The average hourly earnings in May increased 0.3% from April, slightly decelerating from the 0.4% increase the previous month. Year-over-year wage growth in May rose by 4.3%, a slight improvement from April’s 4.4% YoY rate.⁷ The Fed has indicated that 3.5% year-over-year wage growth could be acceptable and compatible with its inflation target, which puts current wage growth within a percent of that goal.⁸

The Fed raised the benchmark fed funds rate by a quarter percentage point at the May 2-3 meeting. The idea that the Federal Reserve may pause interest rate increases at its June 13-14 meeting received some clarity in May. Comments made by Fed leadership in the month appeared to confirm the pause, while also leaving the door open to possibly resume hikes later in the summer. Fed governor Philip Jefferson – who has been nominated to serve as Fed vice chair – said that “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.” He added that “skipping a rate hike at a coming meeting would allow the committee to see more data before making decisions about the extent of additional policy firming.”⁹

 Given that inflation remains sticky, with core CPI rising 5.5% year-over-year in April,¹⁰ the Federal Reserve’s motivation to ‘pause’ hinges on two factors, in our opinion. The first is acknowledging that rate hikes work on a lag, so the full effect on the economy may not be known for months or quarters. The second factor is the regional bank crisis, which may yet result in credit tightening that can serve as a headwind on economic activity and new investment. The April Senior Loan Officer Opinion Survey indicated banks are tightening lending standards, but it’s also worth noting that banks have been tightening for several months now, even preceding the bank stress. March’s failures did not notably accelerate that tightening, according to the April survey.¹¹

Overseas, an economic resurgence in China post-zero-Covid has yet to materialize as investors initially hoped. China’s official purchasing managers index (PMI) for manufacturing activity fell to 48.8 in May, which indicates contraction. Services activity expanded, but we would note that May’s reading marked a deceleration from April’s and also the weakest reading in four months.¹² We believe China also faces many structural problems that may be contributing to underwhelming growth, like a faltering property boom, a very high youth unemployment rate, and strained relationships with Western countries.  

Sources

1. Bloomberg: SPX Index TRA

2. Credit Suisse: U.S. Return Composition – June 2023 pdf

3. https://www.wsj.com/articles/this-rally-is-all-about-a-few-star-stocksand-some-investors-are-worried-b64382e2

4. https://www.marketwatch.com/story/least-loved-treasury-bills-resemble-junk-bond-yields-on-debt-ceiling-anxiety-says-creditsights-3316abf1

5. https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023

6. https://www.wsj.com/articles/a-debt-deal-that-doesnt-deal-with-debt-eef3e608

7. https://www.bls.gov/news.release/pdf/empsit.pdf

8. https://apnews.com/article/inflation-business-pandemics-jerome-powell-federal-reserve-system-01ca0f8ac5439f764827fb89d18a51e7

9. https://www.bloomberg.com/news/articles/2023-05-31/fed-s-jefferson-signals-pause-on-way-but-more-hikes-could-follow#xj4y7vzkg

10. https://www.bls.gov/news.release/cpi.nr0.htm

11. https://www.federalreserve.gov/data/sloos/sloos-202304.htm

12. https://www.cnn.com/2023/05/30/economy/china-pmi-economy-intl-hnk/index.html

As of May 31, 2023

April 2023 | Equity Commentary

Published on May 12th, 2023

Stocks moved slightly higher in the month of April, with the S&P 500 index rising 1.6%. Eight of 11 S&P 500 sectors posted positive performance, with value stocks slightly outperforming growth stocks.¹ Regional bank stress continued to hover in the headlines throughout the month, culminating with the closure of First Republic Bank on May 1—a failure that many market watchers had come to expect.² Trading in regional bank stocks remained volatile, but the muted reaction from the broader markets suggests fear of contagion remains relatively low. The fixed income markets also showed little signs of investors fleeing for safety, with the 10-year Treasury bond yield moving only slightly lower in April, from 3.48% to 3.44%.³

The news of First Republic Bank’s failure also came with an announcement from JPMorgan and the FDIC. Under the agreement, JPMorgan would assume most of First Republic’s $92 billion in deposits and would buy most of the bank’s assets, with the FDIC agreeing to share losses on some of First Republic’s loans. JPMorgan CEO Jamie Dimon and Federal Reserve Chairman Jerome Powell both made statements suggesting that First Republic’s failure marked the end of this chapter of the regional bank stress,⁴ but it’s also true that crises in confidence tend to be very difficult to predict. Regional bank stocks remain under pressure, and we will still need to monitor the downstream effects on credit conditions and loan activity as the year progresses.

The Bureau of Economic Analysis (BEA) reported that the US economy grew by 1.1% in the first quarter, well below consensus forecasts of 1.9% and also the 2.6% growth rate posted in Q4 of last year. According to the BEA, the growth deceleration was primarily driven by a decline in inventories and business investment (as measured by nonresidential fixed investment). A bright spot in the GDP report was consumer spending, which benefited from a surge in retail sales posted early in the year. Imports and exports also increased.⁵

A majority of S&P 500 companies have now reported Q1 earnings, and the overarching takeaway is that corporations largely performed better-than-expected. As of May 5, with 85% of S&P 500 companies reporting results, 79% posted a positive earnings-per-share (EPS) surprise and 75% beat consensus expectations on revenues. According to Factset, Q1 2023 marked the best earnings performance relative to expectations since Q4 2021.⁶ Notably, large money center banks like JPMorgan, Citi, and Wells Fargo all reported strong earnings and expanding net interest margins,⁷ which was partly driven by an influx of new customers leaving regional banks. 

The Bureau of Labor Statistics reported that inflation (consumer price index, CPI) rose by 0.4% in April, following a 0.1% increase in March. Year-over-year, CPI registered at 4.9% in April, down from March’s 5% and February’s 6% year-over-year increase. April’s CPI reading marked the smallest increase since May 2021. Core prices, which strip out food and energy, were higher at 5.5% y-o-y, largely because of pressure in services prices—and specifically the shelter component, which makes up one-third of the index. The upshot here is that shelter prices measure what renters and homeowners are paying for new and existing leases, which means meaningful declines in rents will not show up immediately in the CPI number.⁸ An index of median rents in the US showed the first year-over-year decline since March 2020. Assuming the trend continues, the shelter component should contribute significantly less to the CPI number by this summer and fall.

The Federal Open Market Committee (FOMC) met on May 2-3 and announced another 25 basis point increase for the benchmark fed funds rate, bringing the target rate to the 5% to 5.25% range. In the official statement released after the meeting, the Fed importantly did not include the following sentence: “The Committee anticipates that some additional policy firming may be appropriate.” ⁹ We believe this omission is perhaps the clearest sign that the benchmark fed funds may have arrived at its terminal rate in this cycle. Assuming there is not a negative inflation surprise in the next few weeks, we would expect the Fed to “pause” at its June meeting and hold rates steady until inflation falls much closer to its 2% target.

While the economy has shown some signs of cooling in response to higher rates, the labor market has not. April’s job report showed a 253,000 gain in nonfarm payrolls, following a 165,000 increase in March. The unemployment rate fell to 3.4% in April from 3.5% in March, as 43,000 people left the work force and the number of unemployed Americans fell by 182,000. The three-month moving average of job growth in the US registered at 222,000, which shows hints of softening but not convincingly so.¹⁰

Looking ahead in May and early summer, the debt ceiling issue will likely figure prominently in the headlines. Market participants have largely come to expect a debate over raising the debt limit every few years or so, and many of the same warnings from Treasury officials and demands from political parties play out as they have in years past. It appears that the US will be able to meet obligations and debt payments for another month or two, which unfortunately for investors just extends the timeline that this story is likely to play out in the press. There have been some positive developments recently, with the House’s passage of the Limit, Save, Grow Act in late April¹¹ and a meeting between House leadership and President Biden in early May. While neither development is likely to result in a deal on the debt limit, they at least serve as a starting point for negotiations.

Sources

1.S&P Dow Jones Indices, Market Attributes US Equities

2.FDIC_ Failed Bank Information for First Republic Bank, San Francisco, CA.pdf

3.Resource Center _ U.S. Department of the Treasury.pdf

4.JPMorgan Chase Takes Over First Republic After FDIC Seizes Bank – WSJ.pdf

5.Gross Domestic Product, First Quarter 2023 (Advance Estimate) _ U.S. Bureau of Economic Analysis (BEA).pdf

6.https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_050523.pdf

7.https://finance.yahoo.com/news/analyzing-q1-bank-earnings-good-221610442.html

8.https://www.wsj.com/articles/us-inflation-april-2023-consumer-price-index-48f0eac5?mod=economy_lead_pos1

9.https://www.federalreserve.gov/newsevents/pressreleases/monetary20230503a.htm

10.https://www.wsj.com/articles/april-jobs-report-unemployment-rate-economy-growth-2023-a500d302

11.https://www.nytimes.com/2023/04/26/us/politics/debt-limit-vote-republicans.html

As of April 30, 2023

First Quarter 2023 | Fixed Income Commentary

Published on April 18th, 2023

The financial sector came under pressure in the first quarter following the failure of several U.S. banks.¹ While the prices of many stocks and preferred equity issued by banks were negatively impacted as a result, at present, we do not believe the issuers of the securities held in our client portfolios exhibit the same risk factors which contributed to the recent bank failures. In our view, these factors included significant exposure to cryptocurrency deposits, concentration of deposits in too few firms or sectors, high percentage of uninsured deposits, and securities portfolios with material unrealized losses in excess of the bank’s tangible equity capital.

Background

In simplified terms, when a bank takes in deposits, it can either make loans with those funds or invest them in fixed income securities, typically government or agency bonds. When a depositor withdraws cash from a bank, the bank can either sell a portion of its fixed income holdings or borrow from various sources to fund the withdrawal request. We believe several recent bank failures were characterized by very rapid and significant requests for withdrawals (a “run” on the bank) combined with the inability to quickly access cash to fund those withdrawals, without realizing substantial losses on banks’ securities portfolios.  

Silvergate

Silvergate developed the first digital currency payments network by an FDIC insured publicly traded bank in 2019.² Companies that utilized its payments network included the major crypto currency exchanges, and the exchange’s clients kept large deposits of digital currencies at the bank. Moreover, the top ten depositor firms by market share made up roughly 50% of total deposits.³ Silvergate appeared to have been troubled with declining deposit balances ever since the failure of FTX (a cryptocurrency exchange), which filed for bankruptcy in November 2022.⁴ In total, $8.1B of deposits (68% of total deposits) left the bank during the fourth quarter 2022,⁵ and on March 8, 2023 the bank announced that a voluntary winddown of operations was “the best path forward”.⁶

Silicon Valley Bank

SVB was a leading bank to the technology and venture capital community in Silicon Valley whose strong relationship with these companies contributed to its substantial deposit growth over the last several years, in our view.  In recent months, however, it appears the bank’s deposits declined at a rapid pace due to the high cash burn rate of their clients combined with a lesser amount of new venture funding for startups coming into the bank as new deposits.⁷ As a result, the bank had to sell a portion of its securities portfolio at depressed market values and “realize” losses of $1.8 billion.⁸ SVB had engaged Goldman Sachs to sell additional equity to help repair the balance sheet damage incurred from the realized losses, but quickly deteriorating market conditions eliminated that possibility.⁸  We believe the combination of this news, along with Silvergate’s downfall just days earlier, caused many depositors to have serious concerns about the financial stability of the bank, and many of them withdrew their funds at the same time, triggering a run on the bank.

In terms of overall credit quality, SVB was very well capitalized.⁸ The bank’s tier 1 capital ratio was in excess of 15% (well above the required minimum), the average loan-to-value (LTV) on the mortgage portfolio was low, and loans only made up 35% of total assets.⁸ Moreover, although SVB was a lender to the technology and venture capital industry, its overall exposure to the riskiest elements of this ecosystem was not high.⁸

In hindsight, we believe what investors overlooked at SVB was the concentration of its deposit base in one industry, venture-funded technology companies, whose secular trends exposed the bank to volatile and ultimately skittish depositor flows. While this alone may not have been enough to cause the bank to fail, when coupled with the high proportion of uninsured deposits, significant unrealized losses in the securities portfolio (large enough to wipe out the bank’s tangible equity capital), and the securities portfolio comprising a substantial portion of the bank’s total assets; taken together we believe these factors contributed to the bank’s overall failure.

Credit Suisse

We believe its Swiss National Bank-brokered combination with UBS helped limit contagion. Because Credit Suisse counterparties Greensill and Archegos failed in 2021,⁹ U.S. banks had time to reduce their counterparty exposure to the Swiss bank, in our view. The Fed stress tests also incorporate counterparty failures and suggest to us that this potential issue will not cross the Atlantic. The failure of Credit Suisse’s AT1 securities caught some investors by surprise, and a subsequent move to redeem AT1 securities by Deutsche Bank sparked a widening in the German bank’s CDS spreads and a selloff in its equity.¹⁰ Our strategy does not hold any European bank securities. 

Portfolio Review

In the wake of these recent bank failures, we have engaged in a detailed review of all the bank-issued securities we own in client accounts for similar risks: deposit concentration in too few sectors or firms, potential deposit flight from high levels of uninsured deposits, and potential unrealized losses embedded in securities portfolios that outweigh banks’ tangible equity capital. 

At present, we do not believe the banks to which we have exposure exhibit deposit concentration that could potentially be problematic; either via over-exposure to a single sector (like SVB) or via too few depositor firms (like Silvergate’s ten largest depositors). We believe the banks in which we have invested have a more diversified and stable deposit base.

We have also re-evaluated the portion of a bank’s deposits that are above the $250,000 FDIC guaranteed level. To us, this indicates the degree to which deposits could potentially be at risk of leaving the bank. Of the 25 largest U.S. Banks, SVB had the highest ratio of uninsured deposits to total deposits, at 88%. The bank with the second highest ratio of uninsured deposits to total deposits was First Republic, at 68%, which was a contributing factor towards our decision to sell the security. At present, we do not believe the other banks in which we are invested face a similar risk of losing deposits at a rapid pace. ¹¹

Taking the analysis further, we assessed the potential impact on each bank’s tangible equity capital if all unrealized losses in “held to maturity” categories of securities portfolios, which record securities at book values as opposed to market values, had to be realized. An analysis of banks we own shows that all except for SVB and Schwab would have sufficient tangible equity capital (a tangible common equity to assets ratio > ~3%) remaining if all securities were sold, and all unrealized losses (after-tax) were realized. ^11,12,13

For SVB and Schwab, tangible common equity ratios would fall to or slightly below zero in this situation.^11,12,13 While this could have been a contributing factor to SVB’s failure, we don’t believe Schwab is at risk of facing similar pressures at this time. To be in a situation where the entire securities portfolio may need to be sold, deposits would also need to rapidly decline, and access to enough liquidity would also not be available, in our view. In Schwab’s case, uninsured deposits make up less than 20% over all deposits, which to us indicates that the bank is not at high risk of facing rapid deposit decline.^12,13 We also believe Schwab has access to plenty of liquidity should the need arise. As Schwab’s CEO Walt Bettinger recently stated in the WSJ, “There would be a sufficient amount of liquidity… to cover if 100% of our bank’s deposits ran off,” “Without having to sell a single security.”¹⁴ Finally, unrealized losses in securities portfolios as of quarter-end 2022 have likely improved materially as Treasury yields have declined substantially since the crisis. ¹⁵

Subsequent to the bank failures in March, the Federal Reserve created a new liquidity facility (the Bank Term Funding Program or BTFP) which aims to help banks meet the needs of their depositors and help forestall any further bank liquidity problems.¹⁶ For the next 12 months, banks will be able to pledge their government bonds and agency mortgage-backed securities (regardless of the securities’ current market values) at the Federal Reserve and receive a loan back in return at the par-value amount of the securities.¹⁶ In other words, banks would not be forced to sell securities at depressed market values in times of stress, given the opportunity to borrow more than they are worth from the Fed. Banks also have access to additional liquidity sources such as the Federal Reserve’s discount window, as well as the Federal Home Loan Bank, where other types of collateral (besides treasuries and agency MBS) can be pledged.¹⁷

Outlook

While we do not foresee another bank failure impacting the portfolio at this time, we do believe bank profitability could face potential headwinds in the future. To retain customer deposits, banks may have to pay higher rates on deposits to prevent them from leaving and seeking higher returns. Banks may also reduce lending activity to hold more liquidity on hand just in case deposits were to decline. Moreover, should banks have to utilize additional sources of liquidity, they would have to pay interest on the borrowed funds to do so. Each of these factors could potentially reduce banks’ net interest margin, which is the difference between what banks earn on their assets vs. what they pay on their liabilities, and this could negatively affect their overall profitability.

Another area we are watching is the commercial real estate sector, specifically banks’ and life insurers’ loan exposure to office and retail properties. Higher interest rates and a shift to work-from-home trends that may permanently increase office vacancy levels could continue to pressure valuations of some commercial real estate. While this could have an impact on banks’ earnings or capital ratios in the future, for the US banks we own, we do not expect the impact to be material. In a stressed scenario that assumes a 21% default rate and 41% loss severity on office property loans and a 15% default rate and 42% loss severity on retail property loans, the annualized after-tax impact to banks’ capital ratios would be less than < 1%.¹⁸ For insurance companies, we believe the impact from deteriorating commercial real estate and CMBS fundamentals would also be manageable. Life Insurance companies’ commercial real estate loans are characterized by low LTV’s with long duration fixed rates and debt service coverage, on stabilized properties with very low overdue/default rates, and their CMBS exposure exists to highest rated CMBS tranches.¹⁸ In a draconian scenario that assumes office occupancy declines of 30% and default rates that reach 35%, investors in investment grade tranches of CMBS would generally be protected.¹⁸

We also continue to monitor the overall level of deposits in U.S. banks. Each week, the Federal Reserve releases reports which show the aggregate deposit levels for large and small/mid-sized banks have declined $411 billion since the first week of March.¹⁹ While this may seem like a large amount, it represents just ~2% of all U.S. banks’ deposits. Further, the largest banks may have been beneficiaries of the crisis because depositors believe they are too big to fail. The weekly Fed data shows a market share gain by the largest banks since the crisis even as total systemwide deposits have declined.¹⁹ In fact, Bloomberg reported that Bank of America collected $15 billion of deposits in the first week following the SVB and Signature failures.²⁰ Additionally, the $30 billion rescue of First Republic by the private sector suggests the cohort of large depositor banks have more than sufficient liquidity.²¹ We hold many securities of this cohort whose credit may have improved in the last month.  Weekly regional Federal Reserve data also confirms that the abundance of short-term borrowings have been concentrated in the New York and San Francisco Federal Reserve Banks.²² To us, this indicates that the crisis has not spread far beyond those areas where Silvergate, Silicon Valley and Signature Banks are located.

In terms of the overall economy, we expect the Federal Reserve to rely on incoming data to determine appropriate monetary policy moving forward. On one hand, consumer spending is still growing at an annual rate in the high single digits²³, the labor market is still strong²², corporate balance sheet fundamentals are solid²⁴, supply chains are recovering and credit losses at banks are still very low, implying that the economy is still in good shape.²⁵ On the other hand, we believe given the recent banking crisis, expectations for lending standards to tighten, and what appears to us to be a slew of recent weaker macroeconomic data that have missed expectations, the outlook for the economy and the Federal Reserve’s future actions may become more uncertain.

At present, we believe the portfolio is well positioned to withstand potential volatility from macro-economic uncertainties and any additional impacts from the crisis in the banking system. We will be scrutinizing first quarter earnings reports for uninsured deposit flows, the value of securities holdings, and any borrowings from emergency liquidity facilities. We will also be focused on the quality of CRE portfolios including delinquencies and credit reserves. We do not expect the banks we own to experience similar rapid deposit declines, and we believe the situation for any bank that needs quick access to liquidity has improved due to recent actions taken by the Federal Reserve in creating the BTFP. We continue to monitor the portfolio’s credit quality and interest rate sensitivity, as well as US banks’ deposit levels, exposure to commercial real estate and other metrics that could potentially impact any of our positions.

Sources

¹ https://www.spglobal.com/marketintelligence/en/news-insights/blog/snapshot-the-ripple-effects-of-2023-bank-failures

² https://ir.silvergate.com/news/news-details/2019/Silvergate-Announces-Closing-of-Initial-Public-Offering-of-Common-Stock/default.aspx

³ https://seekingalpha.com/article/4559549-silvergate-capital-depositors-at-the-gates

⁴ https://www.reuters.com/technology/silvergate-capitals-crypto-related-deposits-plunge-fourth-quarter-2023-01-05/

⁵ https://ir.silvergate.com/news/news-details/2023/Silvergate-Capital-Corporation-Announces-Intent-to-Wind-Down-Operations-and-Voluntarily-Liquidate-Silvergate-Bank/default.aspx

⁶ https://ir.silvergate.com/news/news-details/2023/Silvergate-Announces-Select-Preliminary-Fourth-Quarter-2022-Financial-Metrics-and-Provides-Business-Update/default.aspx

⁷ Q1-2023-Investor-Letter.FINAL-030823.pdf

⁸ Q1-2023-Mid-Quarter-Update-vFINAL3-030823 (1)

⁹ Credit Suisse, Burned By Archegos And Greensill Scandals, Shifts Focus To Wealth Management In Overhaul.pdf

¹⁰ Deutsche Bank shares slide after sudden spike in the cost of insuring against its default.pdf

¹¹ Barclays: “State of the Industry Spring 2023” Slides

¹² schwab_annual_report_2022.pdf

¹³ Calculations based on data from Schwab’s Consolidated Financial Statements as of 12/31/22

¹⁴   https://www.financialadvisoriq.com/c/3995094/511764/schwab_lose_bank_deposits_stay_open

¹⁵ Bloomberg USGG10YR Index.docx

¹⁶ Federal Reserve Board – Federal Reserve Board announces it will make available additional funding.pdf

¹⁷ https://www.occ.treas.gov/publications-and-resources/publications/comptrollers-handbook/files/liquidity/pub-ch-liquidity-previous.pdf

¹⁸ JPM_Commercial_Real_Esta_2023-03-23_4367489.pdf

¹⁹ https://www.federalreserve.gov/releases/h8/current/h8.pdf (For the weeks ending March 08, 2023 – March 29, 2023)

²⁰ https://nypost.com/2023/03/15/bank-of-america-gets-15b-in-new-deposits-after-svb-collapse/

²¹ https://www.cnn.com/2023/03/16/investing/first-republic-bank/index.html

 ²² https://www.federalreserve.gov/releases/h41/current/default.htm

²³ https://www.bls.gov/opub/ted/2022/consumer-prices-for-food-up-7-9-percent-for-year-ended-february-2022.htm

²⁴ https://www.bls.gov/news.release/empsit.nr0.htm

²⁵ Global Supply Chain Pressure Index_ March 2022 Update – Liberty Street Economics.pdf

As of March 31, 2023

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   

Sources

1.https://www.ubs.com/global/en/media/display-page-ndp/en-20230319-tree.html

2.Bloomberg: SPX Index and Nasdaq 1Q Performance

3.Bloomberg: USGG10YR Feb Mar Monthly Yield

4.https://home.treasury.gov/resource-center/data-chart-center/interest rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023

5.https://privatebank.jpmorgan.com/content/dam/jpm-wm-aem/global/cwm/en/insights/eye-on-the-market/silicon-valley-bank-failure-jpmwm.pdf

6.https://www.wsj.com/articles/ubs-offers-1-billion-to-take-over-credit-suisse-bfac51fa?mod=djemRTE_h

7.https://www.wsj.com/articles/are-taxpayers-on-the-hook-for-svb-and-signature-bank-deposits-f9d22cf5?mod=hp_theme_svb-ribbon

8.https://www.fisherinvestments.com/en-us/insights/market-commentary/putting-the-regional-bank-scare-into-perspective

9.https://www.fisherinvestments.com/en-us/insights/market-commentary/the-early-deposit-and-loan-data-postsilicon-valley-bank-are-in

10.https://www.wsj.com/articles/banking-turmoil-tests-the-american-consumer-377d4c1b

11.https://www.wsj.com/articles/transcript-fed-chief-powells-postmeeting-press-conference-1b9b2bd1

12.https://www.wsj.com/articles/fed-raises-rates-but-nods-to-greater-uncertainty-after-banking-stress-6ae9316f

13.https://www.wsj.com/articles/consumer-spending-personal-income-inflation-february-2023-526279fe?mod=economy_lead_story

14.https://www.wsj.com/articles/us-economy-retail-sales-february-2023-6b98a40b?mod=djemRTE_h

15.https://www.wsj.com/articles/u-s-job-openings-dropped-in-february-d797e86b?mod=economy_lead_story

16.https://www.wsj.com/articles/us-economy-retail-sales-february-2023-6b98a40b?mod=djemRTE_h

17.https://www.reuters.com/markets/funds/us-money-supply-falling-fastest-rate-since-1930s-2023-03-29/

As of March 31, 2023

March Madness: Part Two – Bracket Busters

Published on March, 21st, 2023

After a tumultuous week that saw a California-based crypto-focused bank (Silvergate Bank) wind down its operations¹ as well as the seizure by U.S. regulators of two other banks (Silicon Valley Bank² and Signature Bank³), the following week many college basketball fans gathered to watch their teams play in the NCAA tournament.  At the same time that many fans saw their brackets implode as a result of surprise losses, investors in the banking sector experienced their own shock and disbelief as bank shares generally continued to decline.⁴  Concerns of both depositors and investors appear to remain elevated despite actions by the Treasury that it had hoped would stabilize the situation.⁵

At present, we believe bank investors may be asking the following questions:

• Will there be more bank runs necessitating government intervention or seizure?
• Could Credit Suisse – or another “too big to fail” institution – be among them?⁶
• Will banks somehow be forced to realize heretofore unrealized losses on bank balance sheets that will materially impair their shareholders equity?⁷
• Might many bank depositors grow so concerned that they shift their deposits to the largest banks?⁸
• Will the Federal Reserve continue to hike interest rates despite recent turmoil in the banking sector?⁹
• Do the recent bank seizures mean that smaller banks are going to see much more stringent regulations that will crimp their margins and ability to lend?¹⁰
• Is this episode going to cause a pullback in lending by smaller banks, slowing the U.S. economy enough to cause a recession?¹¹

At this point we cannot know if there will be additional bank failures.  We are monitoring a number of items to help us assess the situation.  Each week, the Fed shares information on its balance sheet, including bank borrowings at the Fed’s discount window, as well as usage of the new Bank Term Funding

Program the Fed created on March 12 to help provide funds to any banks needing them.¹²  Once things calm down, we would not expect to see much activity here.  We are also monitoring changes in the spread between the overnight lending rate set by central banks and the three-month interbank lending rate; this spread changes from minute to minute and over the past week it has been quite elevated.¹³  We believe its current level prices in a significant amount of fear and risk aversion; if this spread were to fall considerably, we would take it as a sign that concerns have eased. 

Moreover, in our view, bank stock prices can be a signal in themselves.  George Soros coined the term “reflexivity” to indicate the strange concept which is the opposite of what we believe to be true most of the time – that corporate fundamentals drive the price of a security.¹⁴  With reflexivity, a security’s price can drive fundamentals¹⁵ – in this case, a rapidly falling bank stock price might induce fear in depositors, adding to their concerns and convincing them that withdrawing their money and placing it in another bank is the right course of action.  This can become a vicious cycle, we believe, as more withdrawals may lead to a lower stock price, and so on.  Additional policy and/or funding announcements from the Federal Reserve may also act to change investor sentiment regarding the possibility of further bank problems. 

Our team has been delving into these issues ever since the FDIC seized control of Silicon Valley Bank.¹⁶  While the situation is still developing, it appears that over the weekend of March 18^th the Swiss government is encouraging UBS to take over all or parts of Credit Suisse (CS)¹⁷, which in our view may forestall further problems that might otherwise develop if CS was left to sink on its own.  It seems unlikely to us that CS would be allowed to fail, given that it is a global systemically important bank¹⁸ and we believe the Swiss central bank has the means and the will to save it.  If this transaction is agreed to, one significant ‘problem child’ of the last two weeks would be removed from the list of investor concerns, in our view.

We believe U.S. banking analysts over the past ten days have been laser focused on several metrics to assess the likelihood of additional problems arising in the banking system.  In our view these may include the average deposit size at a bank and whether it is above the FDIC’s $250,000 insured amount, and relatedly, the percentage of a bank’s deposits which exceed that amount, the “uninsured” deposits.¹⁹  With this information, analysts may seek to assess a given bank’s risk of having larger depositors potentially move their funds elsewhere due to concerns about being over the insured level. 

We believe analysts are also scrutinizing bank balance sheets to determine if their bond portfolios have experienced losses, and if so, how large those losses might be relative to shareholder equity.²⁰  Current accounting rules permit banks to hold bonds that have unrealized losses without negatively impacting equity, as long as those bonds are designated as “held to maturity.”²¹  By focusing on this measure, analysts may hope to determine the risk that if a bank is forced to sell bonds in order to meet depositor withdrawals, that it might have to realize these losses, and what the impact upon the bank’s equity might be.²²  If equity is wiped out by realized losses from selling bonds, a bank may become insolvent. We believe this was the situation that management of Silicon Valley Bank found themselves in when depositors rushed to withdraw huge amounts of deposits from the bank in a very short period.²³

It’s difficult to know in the aggregate how bank depositors have been reacting to recent events.  Banks are not required to report deposit levels daily, so over the course of the last week it is impossible to know – unless a particular bank decides to make a public disclosure²⁴ – whether that bank is seeing depositors take funds out, move funds in, or leave them be.  It seems likely to us that the largest banks have been seeing inflows, given that they are considered too big to fail.  In our view, the recent announcement by a group of the largest U.S. banks to shift $30 billion of their deposits to First Republic would seem to indicate that those banks may have experienced significant deposit inflows, and therefore were comfortable participating in efforts to help a peer recover from what may have been material deposit outflows.²⁵ 

We are concerned that smaller banks may see higher costs of funding, increased regulation, and potentially changes in how ratings agencies assess their level of credit risk.²⁶  Collectively these changes could cause headwinds for the U.S. economy, since smaller banks have been more significant engines for loan growth than larger banks.²⁷  As credit becomes more difficult to access at smaller banks, borrowers may seek loans from larger banks.  However, lending is a relationship business, and larger banks generally will not have the same relationships with these borrowers that their smaller bank lending officers did.  We believe this is likely to result, in the aggregate, in a decline in the extension of credit.²⁸ Offsetting this pressure to some degree, a lot of loans made in the U.S. economy come from non-bank institutions, such as insurance companies, private equity firms, and other alternative asset management firms.²⁹  In addition, we believe mortgage lending is less likely to be impacted by this particular issue, given the government’s involvement in purchasing conforming mortgages and packaging them into mortgage backed securities.³⁰

Could a decline in credit extended by smaller banks tip the economy into recession?  Many investors have been concerned about the possibility of a recession since the middle of 2022 when yield curves began to invert.³¹ We believe the recent bank failures increase the odds of recession. One offset is that the Fed is now more likely to be less aggressive with future interest rate hikes, and in fact the futures market is telling us at this time that investors now expect the Fed to cut rates as soon as June³².  Some of the prior rate hiking cycles saw the Fed hike into a serious problem or crisis, and as a result the Fed paused and sometimes reversed, and this succession of events did not result in a recession for many years into the future.³³ 

Martin Zweig, the respected investor and market forecaster, coined the phrase “Don’t Fight the Fed” in 1970³⁴, explaining his view that Federal Reserve policy can drive the market’s direction.  If we are indeed approaching a point where the Fed will be cutting interest rates to offset a recession or period of slower growth, then we may also be approaching a point where investors might feel more comfortable about investing in the stock market.

Source

¹https://ir.silvergate.com/news/news-details/2023/Silvergate-Capital-Corporation-Announces-Intent-to-Wind-Down-Operations-and-Voluntarily-Liquidate-Silvergate-Bank/default.aspx

²https://www.fdic.gov/news/press-releases/2023/pr23016.html

³https://www.fdic.gov/news/press-releases/2023/pr23018.html

⁴Bloomberg. S&P 500 Banks declined 11.2% over the 5 days ended March 17, 2023. See Figure 1.

⁵https://home.treasury.gov/news/press-releases/jy1337

⁶https://www.snb.ch/en/mmr/reference/pre_20230315/source/pre_20230315.en.pdf

⁷https://www.fdic.gov/news/speeches/2023/spmar0623.html The total amount of unrealized losses on bank balance sheets was $620 billion as of December 31, 2022.

⁸https://www.bloomberg.com/news/articles/2023-03-15/bofa-gets-more-than-15-billion-in-deposits-after-svb-failure

⁹https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html As of March 17, Fed Funds futures markets are pricing in a 62% chance of an interest rate increase at the Fed’s next meeting on March 22, 2023. See Figure 2.

¹⁰https://www.nytimes.com/2023/03/15/business/economy/silicon-valley-bank-federal-reserve-regulation.html

¹¹https://www.nytimes.com/2023/03/17/business/economy/economy-banks-recession.html

¹²https://www.federalreserve.gov/releases/h41/20230316/ Federal Reserve Statistical Release H.4.1 showed that, as of March 15, 2023, there were $12 billion of BFTP loans and $153 billion of discount window loans on its balance sheet. There were also $143 billion of other credit extensions to banks in FDIC receivership.

¹³Bloomberg. The Forward Rate Agreement-Overnight Index Swap spread was 0.47% on March 17, up from 0.03% on March 8. Its five-year average is 0.22%. See Figure 4.

¹⁴“The Alchemy of Finance” by George Soros. pp. 2-3. “The Concept of Reflexivity.” Wiley. 1987.

¹⁵“The Alchemy of Finance” by George Soros. pp. 2-3. “The Concept of Reflexivity.” Wiley. 1987.

¹⁶https://www.fdic.gov/news/press-releases/2023/pr23016.html

¹⁷https://www.wsj.com/articles/ubs-in-talks-to-take-over-credit-suisse-ed932b01

¹⁸https://www.fsb.org/2022/11/2022-list-of-global-systemically-important-banks-g-sibs/

¹⁹https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/svb-signature-racked-up-some-high-rates-of-uninsured-deposits-74747639

²⁰https://www.ft.com/content/dff4e577-9282-450c-9ae4-58d6572123e5

²¹https://www.wsj.com/livecoverage/stock-market-news-today-01-05-2023/card/when-held-to-maturity-isn-t-and-why-that-matters-to-silvergate-M3iuQ83zpMGeZLYKQnRv

²²https://www.ft.com/content/dff4e577-9282-450c-9ae4-58d6572123e5

²³https://www.wsj.com/articles/bank-collapse-crisis-timeline-724f6458

²⁴https://www.bloomberg.com/news/articles/2023-03-15/bofa-gets-more-than-15-billion-in-deposits-after-svb-failure

²⁵https://ir.firstrepublic.com/static-files/18c04dea-0d44-43ed-b420-b066d56e1f54

²⁶https://www.nytimes.com/2023/03/15/business/economy/silicon-valley-bank-federal-reserve-regulation.html

²⁷https://www.goldmansachs.com/insights/pages/stress-among-small-banks-is-likely-to-slow-the-us-economy.html

²⁸https://www.goldmansachs.com/insights/pages/stress-among-small-banks-is-likely-to-slow-the-us-economy.html

²⁹https://www.federalreserve.gov/newsevents/speech/barr20221201a.htm Nonbank financial intermediaries, broadly defined, fund nearly 60% of the credit to the U.S. economy.

³⁰https://www.fhfa.gov/about-fannie-mae-freddie-mac

³¹https://www.barrons.com/articles/yield-curve-inversion-bonds-a483aaed

³²Bloomberg – see Figure 3 below

³³Evercore ISI. Weekly Economic Report. March 12, 2023. See Figure 5.

³⁴https://requisitecm.com/pdf/dont-fight-the-fed.pdf

Figure 1 

Figure 2

Figure 3

Figure 4

Figure 5

As of March 21, 2023

February 2023 | Equity Commentary

Published on March, 16th, 2023

The ‘economic good news is bad news’ trade was on in February, with the S&P 500 falling 2.5% for the month. The 10-year US Treasury bond yield rose from 3.5% to 3.9%, essentially reversing January’s move.¹ During the month, we believe inflation readings appeared hotter than financial markets may have expected, and the economy showed few signs of weakening substantially.  This occurred in the backdrop of the Fed having slowed the pace of rate hikes from four consecutive 75bp hikes in June, July, September, and November, to 50bps in December and 25bps in early February.² In testimony before the Senate Banking Committee on March 7, Chairman Jerome Powell said “if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” noting that recent data appeared to mark a reversal in the prior trend of cooling inflation. Interest rates futures markets continue to bid up expectations for the benchmark fed funds rate in 2023. At the last Fed meeting, market expectations were for peak fed funds of 4.9% in May, falling thereafter to a year-end level of 4.3%. By March 6, investors were forecasting a peak rate of 5.5% in September, declining only modestly by year end to 5.4%.³

Inflation data released in February did not offer much encouragement to the Federal Reserve, in our opinion. The Fed’s preferred measure of inflation – the Personal Consumption Expenditures (PCE) price index – increased by 5.4% year-over-year in January, which was slightly worse than December’s 5.3% print.⁴ The Consumer Price Index (CPI) and the Producer Price Index (PPI) continued to show improvements year-over-year, but the pace of deceleration slowed – a point we believe is not lost on market watchers and the Fed. 

The Labor Department reported a 6.4% year-over-year CPI increase in January, which marked only a very modest improvement from December’s 6.5% rate of increase. More worrisome to us was the month-over-month change in CPI, which at 0.5% from December to January was a significant move higher than the previous month’s 0.1% increase. Core prices, which exclude energy and food, were up 5.6% year-over-year, again only a slight improvement from December’s 5.7% year-over-year increase.⁵ Much like January’s CPI report, the January’s PPI improved year-over-year compared to December, but the 0.7% month-over-month from December to January was a sharp reversal from December’s -0.2% decline from November.⁶

We believe the divergence between goods and services continues to be the key sticking point in today’s inflation story. Core goods prices have stabilized while shelter costs (a key component of services) rose at their fastest annual pace since 1982.⁷This inflationary pressure is a byproduct of continued strength in the labor market, coupled with consumers increasingly shifting their spending from goods to services. Consumers spent more in restaurants, bars, and hospitality in January, helping drive a 3% increase in retail sales from December to January – the biggest monthly jump in almost two years.⁸

Energy’s contribution to inflationary pressures also remains high on our watchlist, particularly as the war in Ukraine continues. In response to Western oil sanctions, Russia announced it would cut oil production by 5% in March.⁹ In our view, this move should not impact global oil prices very much, but it does appear to signal Russia’s willingness to potentially disrupt global energy markets.

Regarding the outlook for services inflation, the US labor market continues to look largely unresponsive to Fed rate hikes, in our opinion. Nonfarm unemployment jumped by 517,000 in January, which blew past consensus expectations for a roughly 200,000 increase¹⁰. Initial jobless claims – a proxy for layoffs – were also seen ticking slightly lower in the last week of February, which suggests to us, that employers continue to desperately cling to workers. First-time applications for unemployment benefits fell to 183,000, the lowest reported level since April 2022, and unemployment rate fell to 3.4%, a 53-year low.¹¹ One bright spot for the inflation picture is that average hourly earnings rose 4.4% year-over-year in January, which marked the smallest increase since August 2021.¹²

Economic data in services and manufacturing remains mixed, in our view. In February, S&P Global’s index of services businesses rose to 52.1 pushing it back into expansion territory and marking the strongest reading in eight months. U.S. companies that participate in the surveys reported their first growth in output since last summer and indicated optimism about activity in the months ahead.¹³ 

S&P Global’s February manufacturing index reading rose to 47.3 from 46. in January. While still contractionary, the improvement suggests that activity is contracting at a slower pace, and manufacturers indicated that softer demand has allowed them to work through the backlogs that remain a legacy of the pandemic ISM’s survey also showed contraction.¹⁴ Businesses said they were slowing output in anticipation of weak demand in the first half of 2023, but that expectations were in place for a growth pickup in the second half. A key data point, in our view, from the survey was that the index for input prices moved above 50 for the first time since September, a cautionary sign that price pressures could be creeping higher again.¹⁵

Sources

¹Bloomberg. SPX 500 Index DES. USGG10YR GP Function

²United States Fed Funds Rate – 2023 Data – 1791-2022 Historical – 2024 Forecast

³Bloomberg: Implied Overnight Rate & Number of Hikes/Cuts 12/14/22 and 3/6/23

⁴Personal Income and Outlays, January 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf

⁵https://www.bls.gov/cpi/

⁶Producer Price Index News Release summary – 2023 M01 Results.pdf

⁷https://www.nbcnews.com/business/economy/inflation-rate-january-2023-what-it-means-will-interest-rates-go-up-rcna70401

⁸U.S. retail sales roar back; manufacturing shows improvement _ Reuters.pdf

⁹Russia to cut oil output by 500,000 bpd in March _ Reuters.pdf

¹⁰https://www.cnbc.com/2023/02/03/jobs-report-january-2023-.html

¹¹https://www.wsj.com/articles/january-jobs-report-unemployment-rate-economy-growth-2023-11675374490

¹²https://tradingeconomics.com/united-states/average-hourly-earnings-yoy#:~:text=2%2DYear%20Low-,Average%20hourly%20earnings%20for%20all%20employees%20on%20US%20private%20nonfarm,earnings%20since%20August%20of%202021

¹³Global economic growth accelerates to eight-month high in February _ S&P Global.pdf

¹⁴https://www.pmi.spglobal.com/Public/Home/PressRelease/f982d001dbbe4b4daec4f54d2260874e

¹⁵February 2023 Manufacturing ISM® Report On Business®.pdf

As of March 16, 2023

March Madness

Published on March, 13th, 2023

A series of events last week culminated in the United States Treasury announcing over the weekend that it would take steps to stabilize the banking industry.  These actions included providing access to all depositor funds at two banks which were shut down by regulators, as well as a new funding vehicle to guarantee that all banks have access to liquid funds should the need arise in order to meet withdrawal requests by customers.  The pace at which these events have unfolded is concerning, but we believe these actions by the Treasury should stabilize the banking system and prevent further panic by bank customers.  However, there may be some additional issues which arise in the industry as the full implications of this episode become clearer in the coming days and weeks.

Last week, on March 8^th, the holding company for Silvergate Bank announced that Silvergate would close down and liquidate its operations.  Silvergate was a California-based bank unknown to most Americans that went public in late 2019.¹  The bank described itself as the leading provider of innovative financial infrastructure solutions and services to participants in the nascent and expanding digital currency industry.²  Silvergate also built and operated a 24 x 7 currency exchange where cryptocurrency traders could buy and sell digital currency instantaneously.³  As a result, a large proportion of the bank’s depositors were cryptocurrency traders.⁴

The downfall of Silvergate may have been catalyzed in part by the November 11 collapse and bankruptcy of the FTX cryptocurrency exchange, the details of which are still being analyzed and uncovered.  As a result of the FTX bankruptcy, cryptocurrency investors may have grown more cautious about the creditworthiness of the various entities operating in the crypto world.¹ We believe that as Silvergate’s depositors began to withdraw more and more of their funds, this eventually began to put pressure on the bank’s balance sheet.  (This is referred to as a “run” on the bank.)

In a simple model of a bank’s balance sheet, the bank takes in deposits from customers and uses those deposits to make loans as well as to invest in safe fixed income securities, usually government bonds.   Typically, these bonds are divided into two categories, one of which is very short term and used for funding customer withdrawals, while the other can be thought of as longer term that might be held to maturity.⁵ 

If more withdrawals are requested of the bank than can be funded by the short-term category, the bank must then start to sell bonds from the long-term category.  If those long-term bonds are priced at a loss because interest rates have increased, the bank must realize that loss by selling in order to provide funds back to the customers who are withdrawing their cash.  However, if these realized losses are large enough relative to the net worth of the bank, the bank may end up in trouble.⁵  On March 8^th, this situation appears to have developed at Silvergate Bank.

The very next day (Thursday), Silicon Valley Bank, whose parent is bank holding company SVB Financial Group, also suffered a run by depositors, and its stock price fell by 60%.⁶  That bank’s shares never reopened for trading on Friday and it was seized by the FDIC.⁶ SVB was a somewhat unique bank in that its deposits were largely from start-up companies, many of which had not yet done an IPO.⁷  SVB was also far larger than Silvergate, with total assets at year end of $212 billion compared to Silvergate’s $11 billion.  According to company SEC filings, of SVB’s year-end deposits of $173 billion, just $74 billion were used to fund loans, while the remainder were largely invested in government bonds. 

Just as was the case with Silvergate, SVB’s depositors apparently began to worry about the health of the bank, and many rushed to withdraw their funds.  Ultimately SVB was in a situation where it began to realize losses on its bond portfolio which exceeded the bank’s equity,⁶ which seems to be why it was seized by the FDIC on Friday March 10.  Another bank said to have exposure to crytpocurrency, Signature Bank, was closed down on Sunday by New York state regulators.  Signature Bank had year-end total assets of $110 billion.

The unusual aspect as we see it to the seizures of SVB and Signature Bank is that both banks are apparently not facing problems with bad credit or delinquencies.  Rather, they seemingly faced issues of liquidity and access to capital to shore up their balance sheets in the short term.  We think that is what makes this episode so different, say, than the 2008 financial crisis where there were bad loans that ultimately destroyed the equity capital of many banks in the U.S.⁸  What we saw last week was not a credit problem. We believe that, in general, bank assets are creditworthy, and banks are well capitalized. Many rules promulgated since the 2008 financial crisis have required this, and the Fed conducts annual stress tests on the largest U.S. banks to ensure it.⁹ In our view, those tests were very tough in recent years, and all large U.S. banks passed them.

We believe that the bank seizures, as well as the winding down of Silvergate, can be at least in part tied to the Federal Reserve’s interest rate hikes which began in March 2022 as part of the Fed’s efforts to fight inflation, as well as the reversal of its quantitative easing program, called quantitative tightening.  In past rate hiking cycles, we have often seen that “something breaks” and the Fed has to stop. Examples that we think about include Long-Term Capital Management (1998) and Continental Illinois (1984).

On Sunday March 12, the United States Treasury announced that all depositors of SVB and Signature would be able to access all their funds on Monday. This includes all deposits, even those exceeding the FDIC insured limit of $250,000 per depositor. The Federal Reserve also announced a new Bank Term Funding Program that will lend against Treasury and agency securities at par for up to one year, providing another resource for banks to meet depositor requests for funds should the need arise, in addition to the discount window. For now, we believe these actions are likely to limit further contagion and fears about the health of the U.S. banking industry. That said, it is possible that other factors like rising deposit costs that result from this episode could continue to weigh on at least some banks going forward.

Source

¹https://en.wikipedia.org/wiki/Silvergate_Bank

²https://www.silvergate.com/about-us

³https://www.reuters.com/technology/crypto-focused-bank-silvergate-plans-wind-down-operations-2023-03-08/

⁴https://www.forbes.com/sites/digital-assets/2023/03/02/crypto-bank-silvergate-sees-client-exodus-as-delayed-annual-report-puts-future-in-question/?sh=ceaf9175a197

⁵https://www.imf.org/external/pubs/ft/fandd/2012/03/basics.htm#:~:text=Although%20banks%20do%20many%20things,whom%20the%20bank%20lends%20money).

⁶https://www.wsj.com/articles/silicon-valley-bank-svb-financial-what-is-happening-299e9b65

⁷https://s201.q4cdn.com/589201576/files/doc_financials/2022/q4/Q4_2022_IR_Presentation_vFINAL.pdf

⁸https://www.fdic.gov/bank/historical/crisis/overview.pdf

⁹https://www.federalreserve.gov/publications/comprehensive-capital-analysis-and-review-questions-and-anwers.htm

As of March 13, 2023