Choppy Market & First Ever Social Media Bank Run

During the first quarter of 2023 we finally began to see the effects of the historic rate increases by the Federal Reserve in 2022. We also witnessed the first social media derived bank run in the history of the world. This was not your parents “old fashioned” bank run where you had to actually go to a bank, stand in line, and request your cash. This bank run took place via people’s iPhones and happened incredibly quickly.

Here’s what happened….

Silicon Valley Bank catered significantly to the venture capital industry and starting in 2015 began taking on large amounts of deposits from companies who were going public and swimming in cash. From 2015 to 2021 the IPO market was on fire and SVB was the go-to bank for newly minted public companies. The bank needed to put this cash somewhere safe and decided to buy huge amounts of long-term treasuries from the government. This is not necessarily problematic under normal market conditions.

Cut to 2023 and we have a much different macro picture. The IPO market almost completely dried up as the stock market started to experience losses in 2022, which means the flow of deposits into SVG also dried up. Companies continued to withdraw money from the bank to fund operating expenses, which means SVG had negative deposit flow. In addition to the lack of cash in-flows, the value of their deposit base of long-term treasuries decreased significantly after the Federal Reserve dramatically raised rates in 2022. Remember, the price of bonds moves inversely to interest rates. If interest rates go up, bond prices go down. Again, this is normally not a problem because a bank would typically hold the bond to maturity and in that case the price of the bond would not be an issue. The government would repay the bond in full plus interest. However, what happens if a bank is forced to liquidate their long-term bond positions early due to a lack of cash inflows? This is where things got messy.

Due to the lack of deposit inflows, SVB was forced to raise cash to fund continuing business operations. They decided to sell a chunk of their long-term bond portfolio at a large loss and simultaneously executed a capital raise by issuing additional shares of the company. This set off a chain reaction of prominent venture capital firms telling their clients to withdraw their money. Twitter blew up with tweets from prominent venture capital firms and young tech entrepreneurs telling the world they were pulling their money out of SVB. And the rest is history. Bank runs are sometimes a self-fulfilling prophecy. If enough people spread the word that a bank is insolvent, then eventually enough people will leave the bank for it to actually become insolvent. The era of social media and electronic banking just makes it that much easier for a situation like this to occur. In the end, SVG collapsed in stunning fashion within days.

Now the main question on most people’s minds….

Is the SVB situation unique to itself or is the first shoe to drop in the impending financial system collapse? The short answer: at this point it looks like the situation with SVB and a couple other smaller and similar banks is not an indication of systemic financial system problems. The fact that SVB catered to mostly venture capital clients was a main factor in its demise. The venture capital industry is small and tight knit. Word travels fast within the community, which was a major contributing factor. The larger money center banks have a far more diverse client base, are well funded, and have the backstop of the American government. There are a lot of potential issues to worry about in the market right now, but the stability of the banking system at this point, does not appear to be one of them.

Outlook

We are still patiently waiting for the more widespread effects of the Federal Reserve’s rate hike campaign to be seen. Monetary tightening has a lagging effect. However, I would say that investors are slightly surprised that we have not seen greater effects of the rate hikes in the overall market at this point. The main concerns for investors regarding the effects of the rate hike campaign are as follows:

1. Monetary tightening will cause the banking system to seize up.

2. Monetary tightening will cause corporate earnings to fall.

3. Monetary tightening will cause the economy to slow.

None of these issues have come to pass in a meaningful way, yet. Corporate earnings have not fallen off a cliff like many expected. The banking system appears to be in good shape with the exception of a few unique situations. The economy has continued to be resilient, and the job market is still very strong. Many forecasters are anticipating a mild recession in Q2 or Q3 of this year. If those predictions come to fruition and we do get a mild recession, I would anticipate the market reaction to be negative at first and then quite positive. Markets tend to bottom closer to the beginning of a recession, not when a recession is over like many would think. The market is a forward-looking instrument. Right now, the market is looking forward to a recession. Once the recession is announced, the market will begin looking past the recession and onto the next thing, which is the recovery. According to Fidelity, the average return 12 months after a market bottom is 38%. *Past performance does not guarantee future results.

Another positive sign in the market is that higher volatility growth stocks led by tech have been the strongest performers so far this year while defensive sectors like utilities, healthcare, and consumer staples have lagged. We expect this divergence to come back into balance in the near term, but we do expect that tech and growth will be a favored part of the market moving forward for the rest of this year. The reason for our view is that markets crave earnings growth. When the economy slows, the earnings growth of many companies in the cyclical sectors like financials and industrials, for example, slow as well. During this time investors will likely seek safety in the stocks of companies whose earning power is more resilient and less dependent on a growing economy. Healthcare, consumer staples, and technology are our favorite sectors going into the second quarter because of their earnings growth potential and relative stability in uncertain economic times. That being said, earnings growth, revenue growth, and profitability are the three main factors to be included in any of our models, which is why we believe they are well positioned for the current environment.

The commentary in this article reflects the personal opinions, viewpoints and analyses of the Element Squared Private Wealth employees providing such comments and should not be regarded as a description of advisory services provided by Element Squared Private Wealth or performance returns of any Element Squared Private Wealth client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Element Squared Private Wealth manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.