The Fed Provided the Fire Extinguisher, but Had Also Lit the Match
By Wayne Yi, CFA
On Friday and over the weekend, two large banks experienced a "bank run" that caused the FDIC to step in and take over both organizations. The spark that began with California-based Silicon Valley Bank quickly spread to New York with the shuttering of Signature Bank on Sunday. In order to further stem a contagion through the banking system and calm capital markets, the FDIC, Federal Reserve, and US Treasury announced a joint statement that they would guarantee all deposits at both banks beyond the $250,000 federally insured limits. Furthermore, they announced the creation of the Bank Term Funding Program (BTFP) to provide liquidity support to other banks that request it in exchange for government-related collateral. This should calm markets for the moment. We won't use this update to go into how this happened and how it compares to the 2008 financial crisis (we don't think this is as bad, and money center banks are not the culprits this time, plus they are now in a more defensible position). Rather, we will share our thoughts on the market opportunities present in this environment.
The government's intervention is necessary in the moment, and the market let out a sigh of relief with stocks generally moving higher to start the week. However, we believe this is an overall long-term negative for the banking sector as it increases the costs on the industry to replenish capital at the FDIC as well as the eventuality of higher costs of regulation. It also highlights that even without a recession, the cost of inflation and commensurate rise in interest rates is straining companies in ways that haven't been tested in decades and will result in increased business risk and market volatility. Treasuries have tightened meaningfully over the past few days on market expectations that the Fed may have to pause, if not completely stop, its rate hiking program. Unfortunately, we don't think Chairman Powell is ready to pivot just yet, unless there is non-transitory evidence of a more substantial cooling of wages and inflation. With this new liquidity program, we can see further rate hikes without the same fear of something in the financial system breaking… we may hear some creaks, though.
There is no need to panic. Late last week and over the weekend, the Investment team reached out to our investment managers to assess potential exposures to Silicon Valley Bank and other regionals. Fund-level exposure was relatively small, and while venture-backed portfolio companies had larger cash balances that were at risk, the FDIC intervention has mitigated it. Our impacted managers and companies have been opening new accounts and transitioning banking functions over the past several days. Looking forward, these government actions give us time to assess and diversify into defensive opportunities that previously offered little value. With short-term treasuries yielding 4% and high-quality bonds generating over 5%, investors can generate stable income with lower volatility than stocks. On the riskier end of the fixed income spectrum, high-yield bonds and loans, while correlated to equities, had slightly outperformed the S&P500 during the 2008 financial crisis and are currently yielding over 8% per year.
In more volatile markets, we expect multi-strategy and arbitrage-focused hedge funds to better protect capital and grind out steady returns that traditional asset classes cannot capitalize on. We recognize that these vehicles may be less tax efficient and carry higher fees than typical stock and bond funds, but the trade-off of steady returns is attractive in these less certain environments.
Fixed-income assets and alternative strategies like hedge funds were less valuable in a low-rate, benign capital markets environment. However, as we enter the later stages of this economic cycle, diversifying with high quality income and uncorrelated strategies give us conviction and staying power to invest for the long-term and through these bouts of volatility.
Webinar - Wednesday, March 22, 2023
Chief Investment Officer, Wayne Yi, CFA, and the Head of our Client Advisory Group, Tom Morr, CFP®, CAIA, will be hosting a webinar to discuss recent market events and delve further into opportunities in these other asset classes. We will provide our thoughts on the economy and investment opportunities in a higher rate regime, particularly in light of the Silicon Valley Bank insolvency. The Fed will be making an announcement about their rate hiking plans earlier in the day and we will share our thoughts. The webinar details are included below; please use the button to reserve your spot. In the interim, please reach out to us via your client advisor to discuss further.
- Date: Wednesday, March 22, 2023
- Time: 4:00 PM EST
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