The Banking Industry
We want to address what happened last week in the banking industry and explain why the market had such a tough week. Last week the S&P 500 was down 4.5%. Mid-caps were down 7.4%, and small-cap stocks were down 8.1%. The sharp pullback in the market was due to earlier in the week when the Federal Reserve said they still had work to do and expected further rate hikes. After that, later in the week, the news came out about the failure of Silicon Valley bank. Why did the market react negatively to the Silicon Valley Bank news? The best explanation is that Silicon Valley Bank was uniquely at risk because of its unusually low percentage of individual depositors and its unusually high portfolio of loans and securities backing up their deposits. Another problem is that the bank’s clientele was mostly startup companies in the technology and healthcare sectors. On Thursday, the bank had $42 billion worth of withdrawals which left the bank with a negative cash balance. This was immediately followed by regulators stepping in to take over the bank. Silicon Valley Bank was the 16th largest bank in the nation by total assets, so it wasn’t surprising that the market was concerned by its failure. This was the second largest bank failure in U.S. history, so the fears of a 2008 run on the banks scenario were running through investors’ minds. Silicon Valley Bank’s situation is unique, and the news of its failure was initially such a worry because 97% of the deposits at the bank exceed the FDIC’s insurance cap. Silicon Valley Bank was in a class of its own because it had a bad combination of the lowest percent of retail depositors and the highest percent of loans and securities backing up their deposits among all similarly-sized banks in the country. The second worst bank by these measurements, Signature Bank, was suddenly forced into receivership by regulators on Sunday, March 12, 2023. The two banks that regulators took over are the two banks that had the highest risk. It’s important to note that a large majority of U.S. banks are in much better financial shape than the two mentioned; however, this is something that we will continue to watch.
Inflation and The Fed
One of our research partners, Strategas, once said, “Traditionally, the Fed raises rates until something breaks.” A break can be something minor, like in 1998 when the break was long-term capital management. At that time, it was the largest hedge fund in the world, and the Fed came in and had to save it. It could be something significant like the housing market crash in 2008. We’ve already seen parts of the economy break; for example, we saw crypto nearly collapse, we saw the collapse in the tech industry, and the IPO market dried up to near 0, and now we’ve had a bank failure. It will be interesting to see if this failure of Silicon Valley bank is an extension of what we already knew was the broken tech market or if this is a new break in the economy where it may be a weakening the banking system. Only time will answer that, but we do have a short-term indicator of that, which is market expectations for Fed rate hikes. What does the market think the Fed is going to do? Jerome Powell spoke to Congress last week for two days. Over those two days, interest rates spiked as he made it clear that the Fed’s number one goal is to fight inflation, and how they’re fighting inflation is by raising interest rates. On Friday, the news about the banking concerns pulled rates back down. However, tomorrow we will get a new inflation report, and it will be huge to see how market expectations react to that inflation report. We expect a 6% CPI, so depending on whether that CPI number comes in above or below 6% will be telling on a year-over-year basis. It will be more telling to see how the market reacts. Will the market say that the Fed is back focused on inflation, so the expectation is for interest rates to increase, or will the market say that the Fed is focused on the banking sector, at which point interest rate expectations come down? There’s a lot of conflicting data and some tug of war between who will win. Has the Fed done enough to break what they feel is reasonable to bring down inflation, or is there more to go? This is a significant week for data. The inflation data coming out tomorrow is good because we no longer have to wait. We’ve been waiting for this inflation report since the last Fed meeting beginning of February. The next Fed meeting will be on March 22, so we will also keep an eye on that.
According to the recent jobs reports, 311,000 jobs were added. The report also showed that unemployment rose from 3.4% to 3.6%. The unemployment rate rose because there are more people in the workforce. This is proven because the labor force participation rate rose the same amount as the unemployment rate. This is a significant data point because an increase in people looking for jobs is something that we’ve been wanting to see. We still lack in the leisure hospitality sector and would like to see that increase along with the average hourly earnings, but overall, this was a somewhat mixed report which in times like this can be good news. How does all of this impact the Fed? A week ago, there was a 31% chance that there would be a 50-basis point interest rate hike by the Fed. Since this report was released, there’s no chance of a 50-basis point hike. That will be confirmed when we receive the inflation data. Now, there’s an 86% chance of just a 25-basis point hike and, for the first time, a 14% chance of no rate hike. There has been a lot to change in the past week due to this news. We have over a week until the Fed meets, and it will likely be another eventful week for the Fed. We will be watching to see what’s going to happen.
Fi Plan Partners is an independent investment firm in Birmingham, AL, with a team of professionals serving clients across the nation through financial planning, wealth management and business consulting. The team at Fi Plan Partners creates strategies in the best interest of their clients using fee based investing.
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