Market Update – 13th March 2023

A view from the goldfish bowl

Markets can be a goldfish bowl at times. I found this out rather painfully at the weekend. It might well be the most important data set Joe Public has never heard of, but there is very little that stops social conversation as quickly as raising the subject of US non-farm payrolls. The same is largely true about the failure of a bank hardly anybody this side of the Atlantic has dealt with.

However, it is these subjects that will form the basis of this week’s article. They are both exceedingly interesting and vitally important for markets. It also helps that this column’s readership is significantly more informed than your average Joe. Before the butter on that last sentence melts, I best make a start.

Silicon Valley Bank was worth over $40bn in early 2022. It was still worth $6bn on Friday. That proved to be the ultimate falling knife – the equity value has now been permanently destroyed. The cause was the combination of a rush on deposits and the erosion in the value of the bank’s collateral – in this case US treasury stock. It was on the wrong end of $42bn of withdrawal requests from its start-up customers (a quarter of total deposits) in a single day, which forced it to liquidate treasury holdings at losses.

With that run spiralling out of control and cries for help to shore up the balance sheet falling on deaf ears, SVB quickly became the biggest bank failure since 2008. With Signature Bank, a crypto-focused lender, also going under worries about contagion started to spread. In a coordinated move, bodies including the Treasury Department and Federal Reserve sought to repair confidence in the sector. Long story short, funding can now be secured against the par value of collateral like treasuries, which is clearly above the prevailing rate. That provides ample liquidity for any under pressure bank to make good on its deposits.

But there is a clear gap between the value of those deposits and the actual value of collateral. So, who picks up the bill? Losses will not, President Biden has been keen to stress, be made by the taxpayer. The bill will likely be covered by a levy on the banks. Letting investors’ equity go to zero while protecting the innocent businesses who have their cash on deposit feels the correct policy.

The market’s initial response was for a rush to safety, which ironically created buying pressure on treasuries. Remember that weakness in this market was the problem in the first place. Funny how these things work.

Friday’s release of US non-farm payrolls moved sentiment towards government debt in the same direction too. While the addition of 311,000 new jobs represented an 11th consecutive month where the number overshot forecasts, there was weaker data elsewhere. For example, the rate of wage rises was behind expectations, and we also saw an increase in the unemployment rate to 3.6% despite the rise in job numbers. That’s because labour force participation rose to 62.5%, its highest since the onset of the pandemic. The fact people are coming back into the labour market is symptomatic of how they are worried about their prospects. This tells us more than any survey.

With the labour market data not making a convincing case for a sharp escalation in rates, and investors suspecting the Fed might now think twice about significant increases in order to protect the banking system, the overall effect has been for a revision to expectations around where the peak in US rates will be. Quite a significant one too – from 5.7% to 5.3% at the midpoint. This is a silver lining. All else being equal, lower rates are good for asset prices.

I appreciate ‘this time it’s different’ are very dangerous words. But the reality is that while the big names are also incurring losses, there is a lengthy list of reasons why Silicon Valley Bank’s issues are not applicable to the really big, systemically important banks.

First of all, while Silicon Valley Bank is clearly tied to the fortunes of nascent tech and biopharma groups, the big players have a more diverse customer base. They have also managed their books better. JPM was very wary of investing in treasuries in recent years, and took on limited additional exposure even when deposit levels soared. Then there is how they classify the holdings, with banks like JPM often choosing to classify them as held to maturity assets. That limits the impact of their fluctuating value on key ratios. Finally, the big players are more tightly regulated. The reforms introduced after the last crisis mean balance sheet ratios are significantly stronger. Were it not for those changes, which the regulators should be applauded for, we may not have been able to confidently say this is not 2008 all over again.

It is hard to see sentiment towards the banks improving quickly, and the banks are facing a problem. But for the reasons listed above, for the big players, we believe it is not an existential one.

George Salmon – Senior Investment Analyst

Hawksmoor Investment Management Limited is authorised and regulated by the Financial Conduct Authority (www.fca.org.uk) with its registered office at 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. This document does not constitute an offer or invitation to any person in respect of the securities or funds described, nor should its content be interpreted as investment or tax advice for which you should consult your independent financial adviser and or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. The editorial content is the personal opinion of George Salmon. Other opinions expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represent the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. Currency exchange rates may affect the value of investments.