Markets have been rocked in the past couple of weeks by concerns about two very different banks.
Silicon Valley Bank (SVB) is a relatively niche bank in the US, catering mainly to technology firms.
Meanwhile, Credit Suisse is what is known as a “Global Systemically Important Bank” (G-SIB) based in Switzerland. It has now been “merged” (forcibly taken over) into UBS, with help from the Swiss National Bank.
Both ran into difficulties for very different reasons, and this has knocked investor confidence. Stock markets fell sharply, although they have now rallied somewhat, and it is possible there may be a knock-on effect on the economy.
However, we are convinced this is a crisis of confidence and not a crisis in the banking system. Banks are safe, well capitalised and the issues experienced by a few institutions can be contained. This is not 2008.
The intention for this piece is to provide you with information on what is happening, and how it might affect both the economy and portfolios. We hope you find it reassuring.
Some clients just want to know the summary, whilst others want a lot of detail. We sent out a high-level summary of our thoughts last week, which can be found by clicking here.
This post is designed to bring all the information in one place, with optional “deep dives” for those who are interested in the detail. To see the deep dives, click the arrow next to the heading. To hide them, click the heading again.
If you have further questions after having read any of these pieces, please do not hesitate to get in touch.
What happened to SVB?
- SVB lost a lot of money on their portfolio of long-dated government-related bonds. These bonds are normally seen as very secure and if held to maturity, there would be no issues.
- However, because of rising interest rates, the market price of these bonds fell sharply last year.
- Depositors became worried and decided to take their money out, forcing SVB to sell bonds at a loss.
- Once a bank run starts, it is very difficult to stop and usually, the bank fails.
- SVB depositors have been bailed out by the US authorities. The assets of SVB UK have been bought by HSBC for a mere £1*.
For more detail, please click on ‘Silicon Valley Bank – deep dive’ to open/close this section.
Ultimately, no bank on the planet can survive a run on its deposits. For more details on how a bank run starts, please click on ‘Bank run – deep dive’ to open/close this section.
What happened to Credit Suisse?
In short, a litany of scandals and examples of bad risk management over the past few years.
These are completely unrelated to issues with SVB. It is bad timing that further headlines about Credit Suisse appeared after confidence in the banking sector had already been rocked.
Whilst Credit Suisse was well capitalised, given the shaky confidence, depositors and investors started to move away in droves (a version of a bank run), placing the bank at risk of collapse.
In order to try to contain the situation, the Swiss authorities have “encouraged” a merger with UBS, another large Swiss bank.
The Swiss National Bank have provided funding to the new, larger bank to try to ensure confidence and liquidity. They have successfully managed to ensure there was no disorderly failure by a major Swiss Bank.
Shareholders in Credit Suisse received a mere fraction of what their shares were worth a few weeks ago as part of the merger/takeover. Some bondholders have seen their investments completely wiped out, which may knock the confidence of investors in other bank bonds.
However, depositors have again been reassured that their money remains secure.
For more details on the situation with Credit Suisse, please click on ‘Credit Suisse – deep dive’ to open/close this section.
For more information about what it means to be a Global Systemically Important Bank, please click on ‘G-SIB – deep dive’ to open/close this section.
Implications for asset classes
Stock markets fell sharply over the past few weeks.
For example, the FTSE 100 which had been over 8,000 just a few weeks ago, dropped as low as 7,344 on 15 March. This morning (21 March) it had rallied somewhat to trade back over 7,500.****
Shares in banks have been particularly affected, as have the prices of some financial bonds.
On the flip side, government bond prices have gone up.
What might happen to the economy?
Given that confidence was fragile to begin with, we think there could be an impact on the global economy.
Firstly, banks will want to keep back more capital and may therefore tighten lending criteria / be more reluctant to lend.
Businesses may be more likely to hold off on new investments whilst they wait for things to settle down. Consumers may be less likely to spend for similar reasons.
Our base case is now back to being a likely slowdown / possible recession this year (in US, Europe, UK). However, this is still likely to be relatively mild, in our opinion, depending on what happens from here.
On the plus side, this means that the “sticky” service-led inflation may be less prevalent.
Central banks will likely want to pause rate hikes and may even be forced to cut if the economy does take a turn down.
Some estimates are that the “tightening” of credit conditions is equivalent to around 1.5% of rate hikes. If that’s correct, then there is less need to put up rates now and perhaps even a case for a short-term rate cut.
However, it is worth remembering that the economy has done better than expected so far in 2023.
What has happened to portfolios?
Whilst portfolios have dipped, the important thing in our minds is that they have not set fresh lows.
The table below shows how portfolios have performed since the lows of 12 October 2022. It then shows how much each fell from their recent peaks (6 February 2023), as well as the overall returns from 12 October 2022 to 15 March 2023.
| Equilibrium Portfolios | 12 Oct 2022 - 6 Feb 2023 (%) | 6 Feb 2023 - 15 Mar 2023 (%) | 12 Oct 2022 – 15 Mar 2023 (%) |
|---|---|---|---|
| Defensive | 5.81 | -2.33 | 3.35 |
| Cautious | 8.88 | -3.28 | 5.31 |
| Balanced | 10.15 | -3.91 | 5.84 |
| Adventurous | 11.09 | -5.50 | 4.98 |
| Global Equity | 11.37 | -7.18 | 3.37 |
(Source: FE Analytics)
What actions are Equilibrium taking?
We have completed numerous trades in all of our funds to reflect our latest thinking. As usual, we are focused on two main factors, risk and return.
To put it another way, we are making both “attacking” and “defensive” moves. For example:
- Attack: can we take advantage of what we hope will be short-term opportunities?
- Defence: what assets can we buy that might protect us if things get worse?
In summary, we have been topping up equity and other assets as they have fallen. At this stage, we have just gone back to our previous target weights – so if something was meant to be 3% of the portfolio and it dropped to 2.5%, we’ve topped back up to 3% – rather than going overweight. This is known as rebalancing.
In addition, we have made a number of switches in the non-equity parts of the portfolio to buy assets we think are more resilient to further falls, and have reduced exposure to financial bonds (including banks).
Generally, we’re comfortable with positioning as we’ve already been careful to balance risk of a downturn with recent positive economic momentum.
We believe that the “cost-of-living crisis” is nearly over and if inflation does drop to 2.8% later this year (as predicted by the Office for Budget Responsibility), if interest rates do stop rising and if public sector pay disputes get resolved, then perhaps the world can return to some sort of normality.
We hope you have found this interesting and reassuring. As always, if you have any comments, questions, or feedback, we would love to hear from you. If you’re a client you can reach us on 0161 486 2250 or by getting in touch with your usual Equilibrium contact. For all new enquiries please call 0161 383 3335.
*Bloomberg
**FT, Credit Suisse, the world’s 155th biggest bank, 15 March 2023
***CNBC, Credit Suisse posts massive annual loss as radical restructure gets underway
****Refinitiv Eikon / Equilibrium Investment Management
Past performance is for illustrative purposes only and cannot be guaranteed to apply in the future.
This blog is intended as an informative piece and should not be construed as advice.
