Here we go again! Volatility re-emerged in March to the extent that the hope-generating year-to-date gains of the S&P500 were all but wiped out.
If you’ve filled up your tank or been to the grocery store recently, you’re aware that inflation is stubbornly persistent. In response, the Federal Reserve solidified its “higher for longer” approach to combat inflation with ever-increasing borrowing costs charged to members of the federal banking system. The Fed’s end goal is to mitigate the rate of inflation without inducing recession. You can read more about this from our last client communication here. The market clearly believed Fed actions to tame inflation were sufficient until the February “tape” was released indicating that inflation actually ticked upwards a mere .1% above expectations which signaled the beginning of a slow erosion of the 6% gain the market enjoyed year to date.
The silver lining: my 11-year career in financial services corresponds with a low-interest rate environment. Fixed income was fortunate to eke out modest, low single-digit returns and was primarily included in portfolios to reduce stock market volatility for clients nearing or in retirement. That story has changed dramatically over the last year as we have seen nominal yields in short-term U.S. Treasuries touch 5%. Investors are finally being rewarded for being a lending instrument.
Silicon Valley Bank: You may be aware that a prominent, regional bank based out of Santa Clara, California recently failed and was subsequently seized by the FDIC. The same silver lining of higher yields discussed above, ironically proved to be a liability when considering that the bond values held on SVB’s balance sheet had been decimated by the increasing interest rates (recall that bond yield and prices move in opposite directions). SVP was particularly exposed to the unique risks associated with technology industry start-ups and found itself in a position of needing to raise capital to support a segment of the economy that has been particularly hard-hit with layoffs. As a result, SVB was forced to sell assets on its balance sheet at a massive discount including the very bonds it was encouraged to purchase during the pandemic-induced economic shutdown. While any U.S. financial institution shuttering its doors is disconcerting, I do not believe SVB is a harbinger of things to come.
The finance sector took a disproportionate hit in terms of share-price performance last week, undoubtedly related to the collective exposure to the same low-yield/price-suppressed fixed income as SVB, however, SVB’s niche exposure to technology-industry start-up companies appears to have been its downfall. The market will certainly be on high alert for indications of an outbreak of lost confidence threatening widespread asset sell-off. In keeping with our conviction that markets are efficient, we can be confident that available information to the market will immediately be reflected in stock prices. It is telling that as of the final draft of this commentary, the market opened in positive territory; an unlikely response if the finance sector was under broad threat.
Keep in mind that larger banks have failed in the past, which has not resulted in a cataclysmic failure of the banking or credit system. Additionally, the Federal Deposit Insurance Corporation (FDIC), created in the aftermath of the Great Depression, insures deposits up to $250,000. Finally, securities “custodied” at brokerage houses such as Charles Schwab, Pershing, Ameritrade, etc are fundamentally different from cash deposited at retail or commercial banks. While there may be some overlap in that brokerages can hold cash in your account and pay you interest for that deposit, the core function is to facilitate market participation versus access to liquidity through borrowing and lending.
I end this commentary in typical fashion: your discipline to save and invest over the long term is the reason you’re reading this article. You have something to lose, but the growth and preservation of your savings was realized by staying the course through difficult times. Anecdotally, of the thirty-ish client commentaries I wrote in my career, a disproportionate amount of the content addressed the concerns of the day. There have been many, and there will continue to be reasons to be fearful. In that time, the S&P 500 increased 240%, or 12.9% annually. Not bad! Stay disciplined. I am confident you will continue to be rewarded if you maintain focus on your financial objectives. As usual, please reach out to schedule a time to connect to discuss any concerns you may have.
Disclaimer: All information is for informational purposes. No information detailed here constitutes an offer to sell or buy a security. This summary does not constitute advice. Investors should always seek investment advice specific to their unique financial situation and objectives.
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