Making sense of the markets this week: March 19, 2023

Why are banks suddenly folding?

The big news of the week was, of course, that the 12th biggest bank in the U.S.A.—Silicon Valley Bank (SVB)—essentially went bankrupt. The final details are still being worked out, but the U.K. branch of SVB has been sold off to HSBC. And in Canada, the Office of the Superintendent of Financial Institutions (OSFI) has taken permanent control of SVB’s Canadian assets.

This is a fairly nuanced story that can lead you down a rabbit hole. To really dive in, I recommend this quick refresher on monetary policy.

The best explanation of what happened to SVB I could find was on Derek Thompson’s Plain English podcast. We’ll do our best to quickly summarize the bank collapse here, in order to better understand the broader systemic issues you may need to be aware of. 

• There once was a bank named SVB. Its clients were mainly small- and medium-sized tech-sector businesses.
• Tech businesses and startups love low interest rates so they can borrow money very cheaply to see if their ideas will work. These companies also tend to attract more customers when interest rates are low too.
• Banks loan out much more money than they take in (this is known as fractional reserve banking). But, generally, as long as they have a pretty solid chunk of their assets in “safe assets,” regulators are satisfied.
• SVB had a pretty big chunk of money in “safe assets.” These were long-term U.S. treasuries. The problem with putting all your “safe money” in long-term, non-liquid treasuries is that it’s a really stupid move from a risk management perspective. If interest rates rise quickly, those treasuries won’t be worth as much, so the value of your supposedly “safe” assets shrinks if you have to sell them to give depositors back their money.
• Rising interest rates are also particularly important for small- and medium-sized tech-sector businesses. Rough times for that sector mean much less money to deposit into their bank.
• So, the value of safe assets goes down, and fewer deposits come in. That sounds like a really tough problem to solve for whoever is in charge of risk management. The thing is, no one was in charge of that, as there was no Chief Risk Officer at SVB for the eight months before the collapse.
• Suddenly all at once, everyone realized that this bank didn’t have nearly the amount of safe assets it claimed to have. Businesses collectively decided to pull their money out while they still could.
  That’s how a classic bank run works, folks. Turns out, bank runs are a lot easier if clients spend the bulk of their day communicating at light speed in group chats and social media (being tech startup buddies), and that they have access to their bank accounts via their cells.
• Equally sudden was the conversion of all these “free-market Wild West entrepreneurial” types to “the government should step in and save us socialist” types. Funny how that happens.
• Eventually the U.S. Federal Reserve decided to effectively guarantee client deposits (even the ones over and above their $250,000 Federal Deposit Insurance Corporation (FDIC) insurance line). 
• But, and this is a big difference from the 2008 financial crisis, neither the US Fed, nor the US government, gave any money to the shareholders or bondholders of the bank. Those folks will lose a lot, if not all, of what they had invested.
• Then the U.S. Fed did something interesting: It told all the other banks like SVB that they could come to them and trade in their old treasuries (which were worth a lot less than they used to be) for a loan at their original value.
  Essentially, this is a pre-bailout for the difference between what the treasuries were purchased for, and what their current market value is.
  If SVB could have gotten that deal, it’s pretty likely its collapse could have been avoided.
• Once the U.S. Fed enacted this Treasury “lending backstop,” and President Joe Biden said his government would do, “whatever it takes” to restore faith in the banking system, treasury yields and mortgage rates came down in a hurry. The ball is now in the U.S. Fed’s court, as far as whether it takes this as a sign that tightening needs to pause rate hikes for a while.

https://t.co/NRAlyIA929

— Jonathan Chevreau (@JonChevreau) March 15, 2023

Speaking of bank failure

Oh! Some crypto banks failed, too. But it’s not news anymore when cryptocurrency platforms go bankrupt. (Seen that before, right?) Indeed, it would be a bigger headline these days if a cryptocurrency platform were an honest broker and managed to stay in business. For a few hours, panic in the crypto space really set in when two different “stablecoins” (apparently not so stable) broke below their dollar-peg.

No one wants you waiting in line at bank

One other interesting fact I learned from the Plain English podcast is that the reason banks traditionally have such big lobbies is that it’s critically important from a psychological standpoint that no one ever sees a line forming outside a bank. Obviously the trigger there is, “might as well get my money out now—better safe than sorry.” Suddenly you have a bank run on your hands. It turns out that there is no digital equivalent to the big lobby to hide things behind.

Credit Suisse feels the heat

Last Wednesday, we saw a near-collapse of Switzerland’s banking giant Credit Suisse (CSGN/SWX).

While the confidence crisis and general panic may be similar to what happened to SVB, there are some key differences to note:

• Credit Suisse is a much larger bank, with a balance sheet of ₣530 billion (Swiss francs) (CAD$788 billion) at the end of 2022.
• It is classed as a “globally systemically important financial institution.”
• Credit Suisse has been involved in many negative situations over the past decade, which they’ve been labelled to have “shot themselves in the foot.” They’ve been in commercial trouble for a while now.

By early Thursday, it became apparent the Swiss Government was going to lend the troubled bank ₣50 billion to keep the lights on and reassure everyone that they could get their money out, no need to panic. By the end of the day on Thursday, the stock was up nearly 20% from the previous day, signalling that the Swiss government’s backstop appears to have worked for the time being. Even so, Credit Suisse shares were declining again Friday, down 10% at the time this column was published.

So, the key questions for most Canadians are: “Do I need to care about this? Is my money safe?” The answers may be: “Probably not. As safe as the Canadian government can make it.”

The activities of SVB, regional banks in the U.S. and even Credit Suisse, are not likely to affect the average Canadian’s finances. There is some noise on the edges when it comes to Canadian banks that have some assets in America, but that’s pretty small potatoes. OFSI is watching closely to reassure everyone. And it’s stepped in to take control over SVB’s $864 million in Canadian assets, as noted above in the first section. It’s also worth looking at the Canadian Deposit Insurance Corporation (CDIC), as it has you covered up to $100,000 per account.

Personally, I feel quite confident in Canadian banks. Their earnings reports from two weeks ago were very solid. Each of the big six Canadian banks reported setting aside increasing amounts of money to cover off risk for situations just like what we’ve seen with SVB and Credit Suisse. There are some positive systemic reasons why Canada has not experienced a banking crisis in a long time. Given the negative headlines concerning all things banking at the moment, it might be an opportune time to get some widespread exposure to Canadian banks via an exchange-traded fund (ETF), like the Horizons Equal Weight Canada Banks Index ETF (HEWB/TSX).

Inflation in the U.S.: Where do we go from here?

Amid all this banking chaos, the U.S. Federal Reserve has a big decision to make next week, in regard to interest rates. More now, than at any other time in the past few decades, has the U.S. Fed been put between a rock and a hard place. If the central bank pauses on raising rates, it’s quite possible we could see a bull market in several assets and see inflation ramp its way back up. If it follows through on its hawkish warnings, we could see more structural problems such as bank runs continue.

To complicate things more, the recently released U.S. inflation numbers don’t leave decision makers with an easy path. Prices in February were 6% higher than a year ago. That’s down a substantial chunk from January’s 6.4% inflation, and thankfully, way down from June’s 9.1% inflation–but it’s still far above the U.S. Fed’s 2% goal.

Month-to-month core inflation (which strips out volatile food and energy prices) actually ticked upward from January’s 0.4% to February’s 0.5%. The housing sector was responsible for this increase.

A week ago, CME economists suggested a 30%-plus chance that the U.S. Fed would be considering a 0.50% rate hike. Given the recent events, that’s quickly turned around. Now, not only is a 0.25% rate hike the favourited odds, but there is a 28% chance that there may be no rate hike at all!

At the first signs of the Fed reversing monetary direction, stock markets rallied, mortgage rates dropped, and bond markets decided pretty quickly that interest rates would not stay “higher for longer.” Hold on tight for where we are headed from here. For what it’s worth, I continue to believe that Canadian companies and broad Canadian equity index funds are an excellent place to be right now.

Putting your money where your ETF is

I’ll say this for Jim Cramer: He keeps taking swings.

He gets up there every day, and he doesn’t just watch pitches go by.

Instead, he swings at every single one.

Now, how often he makes contact, or actually puts the ball in play, is another matter entirely.

Ever since Jon Stewart eviscerated Jim Cramer in 2009, I’ve viewed Cramer and his show as simply an interesting distraction. It can be a bit of a weathervane for what active retail traders are doing, and it’s useful as a table-setting discussion in regards to market issues of the day.

That said, the idea that one man can be an expert on every random stock theory that gets tossed his way—and that he’d give those insights away for free—is ridiculous.

It appears many folks have a bone to pick with Cramer: That there’s demand for an ETF product that simply bets against every company that Cramer likes. The Inverse Cramer Tracker ETF (SJIM) is the exact opposite of the Long Cramer Tracker ETF (LJIM). Both products are the creation of Tuttle Capital Management, which happily takes a 1.2% MER fee from you in order to facilitate betting for or against Cramer’s stock picks.

Cramer responded in Twitter earlier this year when news first leaked of a proposed inverse ETF:

As always i welcome people betting against me. I have done this for 42 years. Those who know me know that you would have been betting against Apple at 5, Google since inception, Meta at $18, Amazon at ten, Nvidia at $25 and AMD at $5. i welcome all comers..

— Jim Cramer (@jimcramer) October 7, 2022

Note: Cramer himself has pointed investors towards index funds in the past as well. His standard advice to investing newcomers is to put their first USD$10,000 into an S&P 500 index fund and only after that to start picking individual stocks.

Tuttle also offers a similar long- vs anti-tracker for ARK investing’s Cathie Wood. You can of course invest in ARK under the ticker ARKK, and the anti-ARK ETF is listed under SARK.

So far so good for the anti-Cramer side:

Stock picking is really hard, even when it’s not supposed to be

The common story you hear from hedge fund and big mutual fund managers is that they underperform in bull markets because anyone can make money when the stock market does well, but it’s when “the tide goes out” that professional money managers really earn their keep.

Well, they got the first part right.

In the bull market of 2021, 85% of U.S. large-cap equity fund managers underperformed the S&P 500.

Given how rough 2022 was, one could assume stock pickers would’ve had a much better year, right? Turns out, even in a down year, less than half of those same funds could beat their S&P 500 benchmark.

Sometimes it’s tough to learn that it’s just really hard to pick winners and losers in the stock market.

Just ask Jim Cramer.

Kyle Prevost is a financial educator, author and speaker. When he’s not on a basketball court or in a boxing ring trying to recapture his youth, you can find him helping Canadians with their finances over at MillionDollarJourney.com and the Canadian Financial Summit.

About Kyle Prevost

Kyle Prevost is a financial educator, author and speaker. He is also the creator of 4 Steps to a Worry-Free Retirement, Canada’s DIY retirement planning course.

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