13 Mar Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | -4.5% |
| Nasdaq | -3.7% |
| Aussie All Ords | -1.8% |
Last week we said we were expecting a bit of movement but we did not expect 3 separate US banks to fail in the same week and Powell to get traders thinking he is going to add 50bps next Wednesday.
Let’s talk about the bank failures first.
Silvergate Capital served as one of the main banks for the crypto industry. It was widely known this bank was in trouble for some time so it was no surprise to hear it is closing last week. As you will know, the whole crypto industry seems like a massive ponzi scheme to me, so this news is expected and the impact is minimal.
What was a surprise was the news that regulators have shut down Silicon Valley Investment Bank (SIVB).
Before we get into the detail – rest assured this is a highly unique situation and the contagion risk is almost non-existent. It is a bit of news but the impact is actually minor.
SIVB was a small bank that specialised in banking services for the tech start-up sector. These tech start-ups would raise billions of dollars mainly from Venture Capital firms and burn through these dollars building something that hopefully one day makes a profit for them. Kind of like our mining explorers in a way.
SIVB was not large enough to get on the Fed’s Stress Test radar and if you ask me was very losely run. It offered products to directors like hire purchase of private jets or ways to derive large personal salaries if they parked their investment funds raised by the company with SIVB.
SIVB had about $120billion of client money. Anyone who thinks banks just store this money needs to think how CBA can make $10billion a year by just storing cash?
SIVB took this cash its clients had deposited and purchased securities with it. They bought a whole range of things but to keep it simple let’s just consider it was all bonds.
Bond prices are basically 100 – interest rates. They bought these bonds when interest rates were zero, so basically paid 100 for them. But now that interest rates are 5% these bonds are only worth 95.
That’s ok, as long as you hold the bond to maturity because you will get back the 100.
The problem SIVB ran into was one of higher rates and concentration of clients.
The higher rates this year meant the easy Venture Capital funding money has dried up. Start-ups are therefore burning through their cash without replenishing it.
In order to source funds for a withdrawal SIVB has to sell those bonds it bought – locking in a loss. That loss came to about $1.8billion.
Even that was ok because it managed to raise that money by issuing new shares in itself, dropping the share price by 60%.
But what killed it was those very same Venture Capital firms that had effectively given SIVB the deposits in the first place all chatted and decided they wanted out and requested more withdrawals.
This would have set off a spiraling size of losses for SIVB, so the regulator stepped in and closed up shop.
That news got the market worried and stocks fell 1.5% on Friday.
But since then the regulator has announced they will guarantee all client funds. No surprise here. They had to do it because people worry and don’t understand differences between banks and will think the same could happen to other banks.
In theory it is possible, but highly unlikely.
SIVB was unique and a very different proposition to a traditional retail bank. There is no reason to think the same will happen to other banks, which is why the FDIC has stepped in to guarantee any losses – just to reassure everyone their funds are safe in a bank.
To illustrate just how poorly run this bank was, SIVB even invested funds from client deposits into the same tech start-ups that were holding cash in the bank.
Then there is this. Look at director’s recent transactions:
The CEO selling $3.5million of stock just 12 days ago? Surely he would have known something that close to the entire operation collapsing?
Also amusing was that little loud fellow on CNBC said this just a month ago
Maybe that SJIM ETF isn’t a bad idea after all?
And then this morning news broke of a third bank failing. Signature Bank New York (SBNY) has been closed by State Authorities and again, all depositors will be made whole by the regulator.
SBNY was more of a traditional bank but also heavily involved in crypto and the closing of Silvergate likely had an impact.
The moral of this story is not all banks are equal. These three were heavily involved in either crypto or high-risk tech start-ups. Mainstream banks are very different.
If I am missing something and I am wrong about this, then the Fed will step in anyway. We know that will happen as there is no way they risk a failure of confidence in the financial system.
It’s just another example of the federal reserve bailing out individuals who took big risks that went wrong. It would be nice to see them experience some pain to learn from the experience.
Other banks have seen their share prices hammered on the basis that if one is bad they are all bad. Could be some interesting buys in this little list
With that out of the way, we can turn our attention to Fed Chair Powell.
Powell was interviewed by Congress last week and it was this statement that got markets excited
“If – and I stress that no decision has been made on this – 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”
Markets decided that opened the door to a possible 50bps rise at the next meeting on March 22nd and stocks sold off 1.5%
But it doesn’t. Never has the Fed gone from a reduction in rates to 25bps and then back to 50bps. They always taper off over time and the data hasn’t been strong enough to warrant it yet.
Instead of throwing 50bps at it this time they are much more likely to stick with 25bps and do more of the 25bps. It will end up at the same terminal rate, just take longer to get there. Powell does not want to overdo it and spreading the increases out gives him greater time to assess the impact.
Mind you, I do question the effectiveness of interest rates in the US. About 90% of their mortgages are on fixed rate for 30 years. Unlike Australia where ours are around 70% fixed.
That’s probably why RBA Lowe is slowing down increases and indicating a pause soon while Fed Powell sounds like he does not see an end in sight.
The Aussie battler is down to 0.66 and could well go lower if we get more strong US data.
Like the employment numbers on Friday which showed the US gained 311k jobs in Feb, higher than expected. But the under the bonnet the unemployment rate was higher than expected, the average hourly earnings were less and average weekly hours worked were also less.
The US labour market is slowly reducing, but it is starting from such a high level it will take a long time before we see unemployment where the Fed thinks it will go.
I’ve been feeling sorry for Reserve Bank Chairmen this week. Lowe has copped it hard for telling everyone rates would be low until 2024 and then raising in 2022.
But he was not alone. The Fed said and did the same thing. As did the UK and Europe. We can hardly blame Lowe for getting it wrong in Australia when every country did the same thing.
Still, he is better off than Powell who had to endure this question from Senator Warren last week
“So Chair Powell, if you could speak directly to the two million hard-working people who have decent jobs today, who you’re planning to get fired over the next year, what would you say to them? How would you explain your view that they need to lose their jobs?”
“So, Chair Powell, if you reach your goal, and two million people get laid off by the end of this year, and then, just like in 11 out of 12 times, that unemployment has risen by a point in a single year, it keeps on rising, and then we have got 2.5 million people out of work, we’ve got three million people who get laid off, we’ve got 3.5 million people who get laid off, what’s your plan?”
“You cling to the idea that there’s only one solution: lay off millions of workers. We need a Fed that will fight for families. And if you’re not going to lead that charge, we need someone with the Fed who will.”
What he should have said to her was:
“Look, I have one tool and that is interest rates. It is all I have to use to reduce inflation. Plus you tools in government keep coming up with crazy policies that lead to more inflation. I’d also like to state how much I appreciate your comments and I’m sure your background as an elementary school teacher will be able to help me because I have only been in the industry for 48 years.”
But of course he didn’t. He just sat there and took the heat from this idiot who also wants to let employees have more say in the board of directors of a company. Can you imagine asking 50,000 employees to make decisions on how a company should run?
So where does all this place us right now?
Technically things are not looking as strong as they were for the bulls
But we are still a long way off the lows.
I’ve been saying stocks are not in the buy zone for a while now and they still are not. But we are getting there.
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.