Hello and welcome back for our Market Moment for the month of March. I’d like to spend a few moments to touch on the events of the last week in the banking sector.
As we noted in our Monday email distribution, we are monitoring these events very closely. The failures of Silicon Valley Bank and Signature Bank of New York are of course significant, but, in our view, represent outliers that do not currently represent systemic risk to the broader banking system. Importantly, the rapid and concerted action by various government agencies on Sunday to backstop depositors at these institutions demonstrates resolve in preventing a larger contagion from developing. Earlier this week, the Swiss authorities did a similar action for Credit Suisse.
Greenwood Gearhart does not have exposure to the regional banking sector within its investment strategy and has ensured our client cash balances fall within the insured FDIC limit. We have also reviewed our custodian Charles Schwab and remain confident in their financial resilience. In particular, Schwab has more than 80% of its client cash insured dollar for dollar by the FDIC, a percentage among the highest of US banks. Their strong liquidity profile and continued asset inflows are additional sources of financial strength. Schwab’s long-standing reputation of safety and conservative management remains intact, and you can be confident in Schwab as your provider of custody and safekeeping.
Greenwood Gearhart has long had a culture of risk-management. We play both offense and defense in the management of portfolios. We have been through many tumultuous markets and have always focused on ensuring our client portfolios can not only make it through challenging periods, but emerge stronger. This time is no different.
We appreciate your continued trust and confidence in our firm and remain available to answer any questions you may have. I’ll now pass it off to Johann to provide a more in-depth discussion of what to expect in the coming weeks. Thank you.
Hello and thank you for tuning in for our monthly commentary. Since you last heard from me, quite a bit has happened, as Brock mentioned. The recent bank failures and subsequent government action certainly represent a seminal moment for the market going forward. But even before these events, volatility was rising as markets grappled with renewed hawkishness from the Federal Reserve. Strong employment data and elevated inflation are now in direct opposition to the Fed’s latest supportive measures, which puts them in a rather difficult position going into next week’s meeting.
You’ve seen this conflict play out viscerally in the bond markets, with short-term treasury yields rising over 100 basis points over February and early March only to see that entire move reversed in 3 trading days. This is because the market was steadily increasing wagers of even larger rate hikes only to see all bets off this week. Currently, the market is split on whether the Fed stays the course with a more conservative 25 basis point hike or does no hike at all. To not hike would constitute a powerful signal to the market that the Fed is shifting from their top priority from beating inflation to ensuring financial stability.
Given the importance of interest rates in determining prices, this has driven uncertainty as to the fair value of a wide variety of assets, even beyond the banking sector. However, as is typical in such volatile times, markets are trading as much on emotions as they are fundamentals right now, which underscores the importance of prudent management while the dust settles. While cracks have appeared, the market is extrapolating forward many things that have not and may not occur.
Notably, Silicon Valley Bank and Signature Bank of New York were very much outliers both in terms of having a high portion of their deposits above the FDIC limit as well as poor risk management, which resulted in their bond assets falling in value. The large national banks of which you are familiar have much stronger balance sheets due to a combination of stricter regulation, higher liquidity, stringent capital requirements, and enhanced risk management. This is due largely to regulations that came out of the Financial Crisis; however, many of these rules were subsequently rolled back by Congress on the small and regional banks. This is a large reason why the risks that got out of hand at a few banks are unlikely to occur at the largest banks which are more systemically linked to the overall economy.
The coming week will be critical in terms of proving this to the market. To the extent that the market can stabilize without additional negative surprises, then markets are likely to shift their focus back to the Fed’s rate decision next week and broader economic impact. Data certainly shows that the economy is weakening but exactly how much remains to be seen. Previously, odds were rising as to the Fed’s ability to engineer a “soft landing” and bring inflation back to target. The latest developments complicate their path in achieving this, but to the extent the economic fallout from the bank failures is contained it may still be achievable.
Notably, inflation is in fact falling even if it’s not as quickly as the Fed would like. Reasons for this include declining commodity prices and shipping rates, which drive goods prices lower, as well as slowing wage growth which is a large contributor to services inflation. The unemployment rate also notably ticked up in the latest report, which is a positive signal in terms of bringing about better balance in the labor market. So it’s moving in the right direction, and if the Fed stops hiking too soon because of financial concerns, they run the risk of letting inflation anchor itself in the economy above their target rate.
On the flipside, if they continue tightening into a sufficiently weakened environment, they risk bringing on the recession they are trying to avoid. While a delicate balance, the latest data still suggests a narrow path for the Fed to succeed in this endeavor, particularly if inflation continues to ease on its own without the additional hikes. As we saw with the bank failures, the effects of rapid changes in monetary policy and interest rates are often heavily delayed, which means that the previous hikes are still working their way through the economy and helping to bring inflation down.
We will continue to monitor these developments very closely and ensure that portfolios are well equipped to weather this storm. We also remain on the lookout for new opportunities to add value when the market presents them.
We welcome your questions and comments and wish you and your families well. Thank you for watching.