What to make of the market volatility triggered by bank news. 15 March 2023
This note contains a section on recent developments, our views, what we are watching, and our portfolio strategy. These developments may not mean changes to your portfolio so please contact your Client Advisor for the latest update on your portfolio.
Credit Suisse shares have tumbled more than 28% to an all-time low after its largest shareholder has said it will not invest any more capital. There is evidence that investors are worried about the bank’s creditworthiness. Credit Suisse isn’t part of our equity investment universe and its bonds have never been part of our models. Equity markets in Europe are down 2-3% or even more (at the time of writing).
US Treasuries seem to have benefitted from the bad press that several banks have experienced over the past few days. We are overweight in US Treasuries in our flagship portfolios. The position of equity markets is rapidly changing. We are underweight in equities in our flagship portfolios. The USD has softened as the Fed seems to be pulling back on any interest rate hikes, we expect a weaker USD in 2023. We are monitoring the situation very carefully and will respond as needed.
Our asset allocation models are defensively positioned, with an overweight in safe bonds and an underweight in equities. We have a reduced exposure to equity markets which have a large weight in banks, such as the Eurozone, and own gold as a strategic hedge in our flagship funds
The implications of Credit Suisse and beyond:
European banking stocks are falling sharply today, led by a dive in Credit Suisse shares. The European Central Bank (ECB) tomorrow will decide its next interest rate move. The market is behaving as if interest rates will increase by 50 basis points. We believe this will be the base case too. There’s growing uncertainty on what will happen after this pre-signalled rate hike. We believe the Fed is unlikely to raise rates by 50 bps in March, 25 bps if at all is more likely. There’s also significant uncertainty beyond the March meeting in this case too – the Fed could pause for longer, just like the Bank of England.
Read-across from Silicon Valley Bank:
Despite the announcement of joint US Treasury-Fed support to limit bank runs following the fallout of Silicon Valley Bank (SVB), headlines on possible risks to financial stability stemming from the turmoil of US regional banks continue to grab investor attention. SVB serves California’s tech industries and grew fast alongside those firms during the past few years of low interest rates. But currently higher rates, elevated economic uncertainty, declining venture capital and private equity investments, and high cash burn rates amongst SVB’s clients did put stress on that bank. In short, it seems unlikely that this is a generalised liquidity crisis as SVB faces a liability issue (investing deposits rather than making loans). Most US banks are typically asset-sensitive and, hence, benefit from higher interest rates, though we note that increases in deposit sensitivities are becoming a key focus for investors, and net interest margin may suffer at some banks if rates rise further. In addition, regulations put in place since 2008 have reduced the risk of a systemic banking shock.
Our asset allocation models are defensively positioned with a risk-off stance:
We have a greater exposure to safe asset such as high-quality bonds and a lower exposure to equities. Our greater exposure to US government bonds and European/UK investment grade corporate bonds and reduced exposure to Eurozone equities (which contain a large weight in bank stocks) looks set to benefit. Should further cracks emerge, our reduced exposure to emerging-market and high-yield debt should help. Assets in relatively insulated regions could benefit too, e.g., Asia-Pacific equities look set to act favourably, given the relative isolation from the US banking sector and different growth dynamics. We believe that the lower volatility stocks in the US should fall less than the broad US market. Our cautious flagship portfolios, hold gold as a defensive asset which, alongside high-quality bonds, has also performed positively. It’s too early to say whether this is a start of a bout of broader systemic risk in markets. However, this highlights why we feel comfortable remaining more defensively positioned at this point in the cycle and stand ready to adjust positioning as warranted (e.g., by adding to high-quality bonds and/or gold).
Thoughts on bank equities:
It’s understandable that investors are scrutinising the banking sector very closely, along with other parts of the market that could potentially be affected by these recent events. To some extent, this is because of the impact of the rate rises. But, also, it is because of the news on different financial institutions from both sides of the Atlantic and fears of potential contagion (regardless of whether that’s real or psychological). We’re constantly monitoring and reviewing our holdings as part of our research process. When looking at our banking exposure in our direct equity models we are focused on high-quality banks that are well capitalised and defensive relative to peers. Should conditions in the banking sector become more challenging in the future, we anticipate that our single-line equity selection will continue to outperform.
Past performance is not a reliable indicator of future returns.