The 2023 banking crisis started in March when Silicon Valley Bank (SVB) unexpectedly collapsed after it announced a plan to raise capital. Signature Bank (SB) was shuttered shortly after SVB’s closure. At the time, it was the second and third-largest bank failures in U.S. history. Shortly thereafter, with the assistance of the FDIC, JPMorgan Chase (JPM) announced on May 1 that it will purchase the deposits and most assets of First Republic Bank (FRB). FRB’s failure is now the second-largest failure in U.S. banking history.
How does this compare to the 2008 financial crisis?
It doesn’t. The 2008 crisis was sparked by ultra-easy mortgage lending practices that encouraged borrowers to buy homes they couldn’t afford and take out mortgages they didn’t understand. While Signature Bank was heavy in the crypto space, the common thread in the 2023 failures was a bad bet on interest rates, not poor-quality assets. FRB leaned heavily into jumbo-sized mortgages when rates were much lower. Silicon Valley loaded up on long-term Treasury bonds when yields were at rock bottom levels. When interest rates rose, those assets fell sharply in value, leading to their demise.
We suspect this may not be the last we hear about struggling regional banks.
The decision by the FDIC to fully back the deposits of SVB and SB more than likely prevented a series of bank runs on mid-sized regional banks, which would have greatly increased the size and scope of the crisis. Moreover, the Federal Reserve implemented a new lending facility to allow banks to borrow using high-quality assets as collateral, which helped shore up liquidity and calm frazzled nerves. It’s not that these banks were experiencing the kind of troubles we saw in 2008, but the fear of broader panic was real for those who had deposits that exceeded the FDIC limit. It only takes a few keystrokes on a PC or smartphone to move cash today. Welcome to the world of 21st-century bank runs.
The Biggest Losers In The Banking Crisis
The biggest losers in the recent banking crisis are shareholders of the bank stocks that have been negatively impacted by this industry-wide jolt. These events are likely to have residual impacts that will ultimately negatively affect banking customers either directly or indirectly. The direct impacts may include less money for real estate development, business expansion, and even purchases of cars and homes. The indirect effects include a potentially slower-growing economy.
Debt Ceiling Drama
If there was not enough to worry about with banking, we also have the new drama regarding the debt ceiling. The U.S. Treasury is running up against its ability to borrow to finance government spending, possibly as soon as early June. Without an increase, the U.S. risks default. Republicans and Democrats are far apart, but ultimately, we feel a default is highly unlikely. We believe a compromise will be reached that raises the debt ceiling since the failure to do so would lead to catastrophic consequences for financial markets and the economy. We have been through this many times in the past and we will go through this many times in the future as politicians argue about where to draw lines in the sand before calling a temporary truce.
With All This Bad News, When Is the Recession Starting?
The current level of pessimism is at a very high level which could imply a recession is imminent soon. Unfortunately, predicting recessions is extremely difficult because there is always another side to the story. For example, cash deposits at banks are still at elevated levels, corporate profits have on average, been beating expectations and the jobs market continues to show resilience despite softer economic conditions.
Regardless of whether a recession is coming, it does not necessarily indicate that investment accounts will go down, especially if the bad news regarding a future recession has already been baked into the market. Furthermore, believe it or not, significant pessimism can equal good returns over the long term.
For example, Bank of America regularly surveys asset managers to gauge their sentiment on financial conditions and economic health. From their most recent survey, They also found that fund managers were the most pessimistic about the outlook for the economy going back to 2001. While this may sound negative on the surface, we actually find this to be a positive for our outlook.
We call these contrarian indicators, meaning that when a lot of people are moving in one direction, it may be beneficial to move in the opposite direction. We find this to especially be the case with the fund manager’s sentiment outlook. For each period after the fund manager’s survey showed a very depressed level of sentiment, over the last nine times this occurred going back to 2004, the S&P 500 produced a total return on average of 11.18%, 19.33% and 37.03% over the following 6, 12, and 24 months, respectively.
What Should You Do?
Many people have knee-jerk reactions during scary times. We encourage you not to make reactive decisions as we continually monitor our portfolios based on current market conditions and in the context of each client’s unique circumstances. Please call us if you would like to discuss the current state of the economy in greater detail.
In the meantime, enjoy the warmer weather!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
