Today, Silicon Valley Bank went into receivership. Earlier in the week, Silvergate Capital, another bank headquartered in California, moved to wind down their operations in advance of a forced liquidation. A tough week for the banking sector, especially out in Silicon Valley.
I will use this opportunity to remind our clients that news outlets are businesses that profit from increasing viewers. Nothing increases viewers more than fanning the flames of fear. I am pointing at both ends of the political news spectrum when it comes to their coverage of the financial markets. The news of a bank failure has a lot of meat on the bone. Expect all the news outlets to feast off this bone for days and weeks to come.
While a bank failure of this size must be analyzed for how it could ripple into the broader economy, we do not see a reason for our clients to be concerned. To be clear, we see no reason to fear that a banking contagion is developing. Any comparison to the Great Financial Crisis is wrong-footed and based on a misunderstanding of what is happening in the banking system today.
Who should be worried? Anyone who has over $250,000 on deposit at Silicon Valley Bank. Late-stage initial public offerings that use Silicon Valley Bank. Shareholders of Silicon Valley Bank stock. Employees of Silicon Valley Bank. Companies preparing to receive loan proceeds from Silicon Valley Bank.
Silicon Valley Bank failed on the heels of the unprecedented rate hikes from the Fed. However, you should not view Silicon Valley Bank through the same lens as the broader banking sector. This was not a “boring” bank that deals with deposits from “widows and orphans.” It is a bank that was at the cutting edge of the venture capital industry. They took in deposits from venture capital firms and helped broker deals between entrepreneurs and Wall Street. They did not build their reputation on having the fastest drive through service or gifts for opening checking accounts.
If you have been worried by the news today and you are not someone described above, please take a breath. You will not be directly impacted by the events taking place at that bank. Furthermore, do not equivocate what is happening to Silicon Valley Bank to the broader banking system.
Kessler Investment Group was formed in the midst of the take-under of Bear Stearns in March of 2008 and the failure of Lehman Brothers later that same year. We managed client funds through the events that plagued major international banks during currency crisis of the Euro in the years that followed. Today’s “crisis” falls short of rising to the level of any of these events. While past performance does not predict future results, we see today’s event as something other than a global crisis.
What is beneath the surface of this bank failure is tied to the following issues:
- The Federal Reserve has raised rates with unprecedented speed and magnitude. This was done to slow that economy and, inevitably, the highest risk sectors (Initial Public Offerings and venture capital firms) get hit first.
- The collapse of the cryptocurrency market, vis-a-vi FTX, negatively impacted institutions closely tied to it. Many of these institutions are located in Silicon Valley.
- Cracks are forming in the commercial real estate market in California.
- The biggest technology companies headquartered in Silicon Valley have laid off tens of thousands of employees in recent weeks.
It was a year ago this week that the Federal Reserve started hiking interest rates. In the past year, they have hiked by 4.5%. On March 22nd it is expected they will raise rates again. Whether it be by a quarter, or one half of a percent, we will find out then. It is possible that in twelve months, the Fed will have raised rates by 5%. Astounding.
Keep in mind the textbooks tell us that a hike in interest rates does not impact the economy for 9-12 months. We are only now expected to feel the impact of the first hike that was made in March of 2022. This means we have not felt the impact of the four 75 basis points hikes of last summer. An economic slowdown is ahead but we believe this is why stocks performed poorly in 2022. We do not expect stocks to suffer over the rest of this year like they did in 2022. In other words, we believe much of the economic slowdown has been priced into stocks at current levels.
The Federal Reserve typically hikes rates until it “breaks” something. Afterward, they frequently move to lower rates to release pressure in the system and prevent more “breaks.” This happened following:
- The Savings and Loan crisis of 1990.
- In the wake of Orange County California’s bankruptcy.
- Following the failure of Long Term Capital.
- The Dot-Com Bubble burst and 9/11.
- The Great Financial Crisis.
- In 2019 following a 20% decline in stocks and nine rate hikes in a row.
- COVID
Not every case played out with the same timeline, however, stocks did rally soon after the Fed cut rates. There is a growing possibility the Fed will see Silicon Valley Bank’s collapse as a signal that they are at risk of “breaking” something even more valuable. This could lead them to pause or reverse course on rates and soon.
Summary
The collapse of Silicon Valley Bank should not be viewed as a precursor to a run on banks around the world. It should be viewed as the first sign that the Fed is having an impact on the economy. This suggests to us the Fed is closer to a pause or cut in interest rates than the alternative.
News outlets will amplify the potential for another Great Financial Crisis. Pay these stories little attention. Banks are in substantially better shape than they were heading into the Great Financial Crisis and consumers are not leveraged to the hilt as they were then either.
As always, please feel free to reach out to us with your questions. We take seriously the responsibility you have entrusted to us to manage your precious savings. We will continue to closely monitor the situation in the news today.
Sincerely,
Craig A. Kessler
All information in this presentation is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic performance data is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Certain statements contained within are forward looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Please consult your adviser for further information.
Opinions shared in this presentation are not intended to provide specific advice and should not be construed as recommendations for any individual. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.