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5 minute read
Holy smokes, the tension in the economy right now is off the charts. I feel like I’m watching Breaking Bad or Game of Thrones again. I take my eyes off financial headlines for one second and a flying dragon burns down an entire village. I think what all investors want right now is Ted Lasso or maybe even Friends. We deserve some comfort television for a change, it seems like we’ve been in this thriller for too long.
So, what’s happening in the banking sector at the moment? For starters it’s like Yogi Berra said, “it’s déjà vu all over again”. A few short months ago, Signature Bank, the 29th largest bank in the US, was shut down by regulators on March 12th. Signature was the first FDIC insured bank to create a blockchain-based digital payments platform that was approved by the New York State Department of Financial Services. First Republic was seized over the weekend and bought by JPMorgan in the 2nd largest bank collapse in US history. They tried to hold on for a few months after the bankruptcy of SVB but ultimately failed. Three of the four largest bank collapses in US history have taken place in the last 2 months.
The demise of these banks was caused by “bank runs”. Now, what’s a bank run? I’m going back to the sports analogies to describe this situation because frankly, I’m convinced there is one for just about everything. Recently, my beloved UCONN Huskies won the national championship. We are in the midst of the NBA playoffs and Ben Affleck and Matt Damon came out with the movie AIR, so I’m going to use a basketball comparison. I’m team Michael Jordan but I’m using Lebron James for the analogy.
Stay with me.
Lebron was a unicorn in high school and a once in a generation athlete. Lebron, in this story, was like the technology community. He was innovative, game-changing, pushed the league to new heights, made everyone around him better and he was great for basketball. The Cleveland Cavaliers drafted Lebron and, in this scenario, the Cavaliers reflect Silicon Valley, Signature and First Republic Bank. These banks housed the tech community (Lebron). Overnight, a kid from Akron Ohio gave the Cleveland Cavaliers relevance for the first time in their history. Ohio was buzzing, the arena was sold out, apparel sales were off the charts and in short order the Cavs were contenders. Similar to the rise of the 3 banks in discussion. However, the players around Lebron for the 7 years he spent in Cleveland were mediocre and after 0 titles he started to feel the struggle in the organization and the lack of support from his teammates. Comparable to the feeling of angst and concern that the tech community had when their banks, Signature, SVB and First Republic, started to raise worries.
Lebron started calling his friends in the league, Carmelo Anthony, Chris Paul & Dwyane Wade. Just like how the innovation economy jumped on WhatsApp, Slack and Reddit to discuss their fears about their deposits at the bank. Although Lebron was loyal to Ohio the way tech founders were loyal to their banks, he decided to take his talents to South Beach and join a super team with D. Wade and Chris Bosh. Well, the tech community decided to change banks and they pulled their money out in droves creating a “bank run.” Essentially causing the first social media powered bank run in history. What happened to the banks? They went bankrupt and were sold. What happened to the Cleveland Cavaliers? The following season they sold some tickets for as low as $2 dollars and the team’s record was 19-63 which was good for worst in the NBA. The silver lining for Lebron (the tech community) was that he went on to win 2 championships with the Miami Heat. The silver lining for the Cleveland Cavaliers (the Banks that housed the tech community) was that Lebron came back and brought them an NBA championship.
Now what commonalities do these 3 banks have aside from the fact that Netflix and Martin Scorsese are rushing around putting together the documentary and feature film about the debacle? The main catalysts for all three were the focus on a niche customer base, an abnormally large percentage of uninsured deposits and a large portion of long dated, low yielding assets in their own portfolio.
Many of us know by now that bank deposits are only FDIC insured up to $250k. 94% of Silicon Valley Bank’s deposits, 90% of Signature’s and 68% of First Republic’s were all uninsured.
Finally, we get to the trigger of all this angst. Banks take deposits from customers and either lend that money out or invest in securities. The securities tend to be low risk like treasuries and are no different than the bonds that you all may have in your portfolios. Like you, these assets saw their value decline as the FED raised interest rates at the fastest pace we’ve ever seen. (From Finance 101, yields go up and prices go down and vice versa). These banks increased their deposit rates in order to be competitive. There came a point where market analysts were concerned about the losses recorded at SVB and this quickly spread across the banking industry. Folks started pulling deposits at a rapid pace and these banks were forced to sell assets in a distressed market environment and it became death by a thousand cuts until they went insolvent.
It’s hard to predict if this is the end of the banking crisis. This caught the world by surprise, but the crazy thing is that regulators have since claimed they saw the red flags at SVB and Signature Bank while First Republic was seemingly caught in friendly fire. If regulators indeed saw the signs, then the parameters they use to prevent bank collapse may need work. It reminds me of the Seinfeld scene when Jerry is renting a car. The rental company knew how to “take” the reservation, but they didn’t know how to “hold” the reservation. It’s the “holding” that’s the most important part. If regulators saw the signs but couldn’t prevent the outcome then what good is seeing the signs?
So what’s the game plan? Do we sell in May and go away?
The age-old investing mantra “Sell in May and go away,” refers to the weak historical performance of the S&P 500 from May to October versus the strong performance in the other half of the year. Over the last 33 years the S&P 500 has returned an average of 2% between May and October versus 7% the other 6 months. So why doesn’t every investor act accordingly? Because markets are wildly unpredictable. Look at the beginning of 2020 when Covid brought the market to its knees only to rally and return 12.3% from May to October.
However, this May to October period in particular feels like one to navigate with caution. The FED increased another 25 basis points this week as they continue their attempts to cool inflation. GDP was up just 1.1% in Q1 compared to Q1 a year ago. Economists are forecasting GDP in 2023 as flat to negative each quarter and are predicting a recession in the 2nd half of the year. Core prices, which exclude energy and food, increased 5.6% in March from 1 year earlier and are up from the 5.5% mark last month.
Is the market toppy?
The S&P 500 is up around +7.5% on the year, the Nasdaq 100 is up just over 20% and both indices are trading well above their 20-year average P/E ratios. Valuations don’t look pretty in US Large Cap and the Growth style. The top 6 names in the Nasdaq 100 make up 50% of the index and they are also accounting for roughly 20% of the 21% return.
Seemingly, the market is headed for further volatility so what’s the move?
When the offense can’t find their way, keep playing solid defense. US Large Cap equities and Technology seem risky given valuations and recent earnings. Investing in high grade Corporate Bonds at a 5.5% yield or investing in 3 to 6 month US Treasury Bills at 5% is not a bad place to bide some time. You can’t go broke taking a profit. Also, alternative investments that are uncorrelated or less correlated with the broader market serve an important role in portfolios. Of course, equities belong in the portfolio but paring back the risk by investing in names with strong cashflows, low cost and high tax efficiency feels more responsible. Investors can always put their foot on the gas down the road. A long only or 60/40 portfolio may leave you exposed. And as Warren Buffett said, “it’s only when the tide goes out when you discover who's been swimming naked.”
Disclosures
This information is provided for informational purposes only and does not contain investment advice or an offer or recommendation of securities. Connectus Wealth, LLC d/b/a Connectus Private is an SEC registered investment adviser. Investment does not imply government endorsement or that the adviser has attained a level of skill or training.