Almost sixty years ago, during a speculative attack on sterling following Labour’s election victory, new Prime Minister Harold Wilson quipped to lobby journalists that “a week is a long time in politics”. March 2023 has demonstrated that it is also a month of Sundays in economics. While markets continue to navigate a European war, rampant inflation and aggressive interest rate hikes, along comes a banking crisis.
Or not, as it happens. Unless you had better things to do last month than pore over business headlines, you will have seen how the failure of an idiosyncratic US bank drew investors’ attention to otherwise hidden weaknesses in other banks’ business models. You may further recall many of our missives last year referred to the once-in-a-generation collapse in bond prices, as their yields rose along with interest rates. What many missed was the potential secondary impact this chain of events might have on banks.
Silicon Valley Bank demise
To reiterate our recent commentaries on this issue, Silicon Valley Bank (SVB) made their money by paying a low rate of interest on customers' short-term deposits and used those to make (normally) safe investments in higher-yielding long-term government bonds.
SVB lent money by ‘creating’ it, adding a digital credit to a customer’s account, and in return charging an even higher rate of interest on that loan over the long term. This is how all banks work, so nothing unusual so far.
However, SVB’s customers were almost exclusively start-up technology companies. 2022 was punishing for these businesses, which typically saw their value fall by 40% and more. Funding dried up and so they needed to fall back on their savings – i.e. by emptying their deposit accounts. To pay those deposits back, the bank needed to quickly sell the bonds they held; but as we’re now all too aware those bonds remain worth significantly less than when purchased. Customers with large deposits beyond the US government’s insurance guarantee level withdrew deposits almost instantly online; social media accelerated that process to the point where the bank’s assets could not cover the withdrawals. However, ‘tech-savvy’ it was, SVB was brought down by the oldest issue in banking and one of the few means that can ruin a bank: a run on its deposits.
Ripple effect in Europe
Despite their much larger size, weaker banks in Europe were caught in the ripple effect. Most notable was Credit Suisse, subsequently rescued by a ‘shotgun wedding’ with UBS, steered to the altar by the Swiss central bank. Banks’ shares fell significantly meanwhile, irrespective of their financial strength.
News headlines channelled Private Frazer in the sitcom Dad’s Army, opining ‘We’re all Doomed’, and equity markets (including companies not remotely related to finance) fell by around 8% in the space of a few days.
However, those of us echoing Corporal Jones’s plea “Don’t Panic” have, thankfully been validated so far. Governments have stepped in where necessary to support the banking system, and as I write this (29th March) calm seems to have returned and prices have started to recover. Investors seem to believe that to whatever extent some smaller banks might be in difficulty, their respective central banks will be less enthusiastic about continued punishing interest rate increases, and this will have a positive side effect on stock markets. That said, the US Federal Reserve continues to insist it will not cut rates this year, and indeed increased by another 0.25% in March despite the banking incidents.
The UK, EU, Swiss, and Norwegian central banks also raised rates because inflation remains stubbornly high. Bank of England Chair Andrew Bailey went so far as to claim that the growing number of early retirees has been inflationary and “is part of the reason why we have had to raise Bank Rate as much as we have.” Given the nation’s entire workforce has shrunk by roughly a population the size of Colchester, I’m unconvinced. However, it is arguable that much of the current inflation pressure is profit-led. A queue of grocery industry spokespeople has blamed various crises (energy, weather, Brexit etc) and farmgate price rises for the 17.5% jump in food prices over the past year, although this does not explain the extraordinary increases in the prices of dairy products recently. Shoppers will likely respond by redistributing their supermarket loyalties; note the increased market share by Aldi and Lidl of late - the former displacing Morrisons as the UK’s 4th largest supermarket - and I would anticipate demand shifts may very well encourage significant price cuts on food staples to tempt more discerning shoppers. Any cuts will no doubt be explained at the time as pure altruism by the supermarkets.
The fallout from the banking issues may have had a negative impact on companies’ shares through the month, but this has been countered by the re-emergence of money-market funds and particularly bonds as the risk-reducing assets of choice in portfolios. Conventional Gilts are up over 4% in March, and Index-Linked have risen almost 7%. Even the cash holdings in our portfolios are rising at an annualised rate of around 4%. Lower-risk investors will have seen their portfolios rise during the month despite the headlines implying otherwise.
The experience of 2023 so far supports the view that trying to second-guess market behaviours by reacting to short-term news tends to do more damage than being patient. That remains our mantra, and I look forward to sharing rather more positive news next month.
Chief Investment Officer