Salal Investment Services
Available through CUSO Financial Services, L.P.*
Adrian A. Hedwig
Financial Advisor, CUSO Financial Services, L.P.*
Available by appointment at all Salal Credit Union branches.
Virtual and phone meetings also available.
In the newsletter this month:
Quarterly Market Review:
January – March 2023
The Markets (through March 31, 2023)
Wall Street proved resilient during the first quarter of the year, despite rising inflation, uncertainty about the Federal Reserve’s actions, interest-rate hikes, and banking concerns. Inflationary data in January seemed to show inflation may have peaked, and the Fed would scale back its interest-rate hikes, if not cut them. However, subsequent inflation data showed prices ramped up again. Stocks and bond prices dipped as investors responded to concerns that interest rates would continue to rise and for a longer period of time. In addition to the impact of rising inflation, two major banks collapsed in March, sending bank stocks lower. Credit Suisse Group, nearing failure, was taken over by rival UBS Group, while several U.S. banks provided funds to keep First Republic Bank afloat. The economic recession that has been predicted has yet to come to fruition. The labor market remained strong, and while inflation continued to rise, the two primary indicators, the Consumer Price Index and the Personal Consumption Expenditures Price Index, showed prices slowed on an annual basis.
Despite all of this apparent turmoil, coupled with the ongoing war in Ukraine, stocks regained their footing and ended the quarter on the plus side. The tech-heavy Nasdaq led the benchmark indexes, followed by the S&P 500, the Global Dow, the Russell 2000, and the Dow. Investors poured money back into Mega cap Tech shares, driving them higher during the first quarter of 2023 after an underperforming 2022. Those gains helped drive the Nasdaq and the S&P 500 higher. Even with investors taking some gains from the Mega caps, other market sectors reaped the benefits. Energy stocks, which excelled in 2022, fell in the first quarter of 2023, as did crude oil prices. Gas prices rose minimally higher, with regular retail prices averaging $3.421 per gallon on March 27, $0.14 over prices on January 4. The dollar dipped lower, while gold prices rose higher.
The quarter kicked off with stocks enjoying their best January performance since 2019, as inflation data suggested that inflation may have peaked, raising hopes that the Federal Reserve would scale back interest-rate hikes and temper fears of an economic recession. Nevertheless, Federal Reserve Chair Jerome Powell cautioned that the battle against rising inflation was far from over and additional rate hikes were upcoming. In fact, the Federal Reserve hiked interest rates 25.0 basis points on the last day of the month. Growth stocks performed best, with Mega caps making solid gains. Consumer discretionary, communication, and tech sectors performed well, while defensive sectors, such as utilities, health care, and consumer staples, dipped lower. Bond prices advanced, pulling yields lower. While 260,000 new jobs were added in December, the growth was the slowest in two years. Average hourly earnings rose to the lowest annual level (4.6%) since September 2021. However, manufacturing declined at the fastest rate since May 2020, while services retracted for the third month running, according to the S&P Global Manufacturing PMI™. Nevertheless, each of the benchmark indexes listed here added value, led by the Nasdaq (10.7%), followed by the Russell 2000 (9.7%), the Global Dow (7.8%), the S&P 500 (6.2%), and the Dow (2.8%). Ten-year Treasury yields fell 35.0 basis points, crude oil prices dipped 1.7%, the dollar slid 1.4%, but gold prices advanced 6.3%.
Stocks gave up some of their January gains in February, with each of the benchmark indexes losing value. The Dow (-4.2%) fell the furthest, followed by the Global Dow (-2.7%), the S&P 500 (-2.6%), the Russell 2000 (1.8%), and the Nasdaq (-1.1%). Bond prices declined, driving yields higher, with 10-year Treasury yields advancing 39 basis points. Crude oil prices decreased 2.8% to $76.86 per barrel. The dollar rose 2.8% against a basket of currencies. Gold prices lost most of their January gains, falling 5.7% in February. Consumer prices advanced, with core prices (excluding food and energy prices) climbing 0.6%, the biggest advance since August. Over 500,000 new jobs were added, nearly three times the consensus estimates, and the largest increase in six months. The unemployment rate slid to 3.4%, its lowest level since 1969. Consumer spending rose 1.8%, the most in nearly two years.
March was a very choppy month for market returns. Despite an apparent banking crisis, investors stayed the course for the most part, driving stocks mostly higher. The Nasdaq and the S&P 500 led the gainers of the benchmark indexes listed here. Several sectors outperformed, including information technology, communication services, and utilities, while financials fell notably on the heels of the aforementioned bank failures. Manufacturing retracted, while services advanced, according to purchasing managers surveyed. Labor remained strong, with 311,000 new jobs added. Hourly earnings rose by $0.08 for the month and 4.6% since February 2022. The Consumer Price Index rose 0.4% after falling 0.5% the previous month. The PCE price index increased 0.3% and 5.0% over the past 12 months. The economy advanced at an annualized rate of 2.6% in the fourth quarter, short of the 3.2% increase in the third quarter. Crude oil prices and the dollar declined, while gold prices climbed higher.
Stock Market Indexes
As of March 31
|4.25% – 4.50%||4.75% – 5.00%||25 bps||50 bps||50 bps|
|3.87%||3.49%||-42 bps||-38 bps||-38 bps|
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Latest Economic Reports
- Employment: Job growth remained strong in February with the addition of 311,000 new jobs, compared with an average monthly gain of 343,000 over the prior six months. Despite federal interest-rate hikes aimed at slowing the economy and inflation, there is little evidence that the supply of labor is peaking. In February, notable job gains occurred in retail trade, government, leisure and hospitality, and health care. Employment declined in information and in transportation and warehousing. The unemployment rate edged up 0.2 percentage point to 3.6%. in February, the number of unemployed persons rose by 242,000 to 5.9 million. The employment-population ratio, at 60.2%, was unchanged in February, while the labor force participation rate, at 62.5%, edged up 0.1 percentage point from the previous month. Both measures have shown little net change since early 2022. In February, average hourly earnings increased by $0.08 to $33.09. Over the past 12 months ended in February, average hourly earnings rose by 4.6%. The average workweek decreased by 0.1 hour to 34.5 hours in February.
- There were 191,000 initial claims for unemployment insurance for the week ended March 25, 2023. The total number of workers receiving unemployment insurance was 1,689,000. By comparison, over the same period last year, there were 171,000 initial claims for unemployment insurance, and the total number of claims paid was 1,506,000.
- FOMC/interest rates: The Federal Open Market Committee met March 21-22, at which time the Committee increased the Federal Funds target rate range by 25 basis points to 4.75%-5.00%. The statement from the FOMC indicated that it is “strongly committed to returning inflation to its 2.0% objective.” The Committee also noted that it would consider adjusting its policy stance based on “labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”
- GDP/budget: Despite rising interest rates and accelerating inflation, the U.S. economy advanced in the fourth quarter of 2022. The economy, as measured by gross domestic product, accelerated at an annual rate of 2.6% in the fourth quarter of 2022, according to the third and final estimate from the Bureau of Economic Analysis. GDP increased 3.2% in the third quarter after falling in the first and second quarters, 1.6% and 0.6%, respectively. The deceleration in fourth-quarter GDP compared to the previous quarter primarily reflected a downturn in exports and decelerations in consumer spending, nonresidential fixed investment, and state and local government spending. These movements were partly offset by an upturn in private inventory investment, a smaller decrease in residential fixed investment, and an acceleration in federal government spending. Imports, which are a negative in the calculation of GDP, decreased less in the fourth quarter than in the third quarter. Consumer spending, which accounted for about 70.0% of GDP, rose 1.0% in the fourth quarter compared to an increase of 2.3% in the third quarter. Consumer prices increased 3.7% in the fourth quarter (4.3% in the third quarter). Excluding food and energy, consumer prices advanced 4.4% in the fourth quarter (4.7% in the third quarter). In 2022, consumer prices increased 6.3%, compared with an increase of 4.0% in 2021. Overall, In GDP increased 2.1% in 2022, compared with an increase of 5.9% in 2021.
- February saw the federal budget deficit come in at $262.4 billion, $223.6 billion over the January deficit and $45.8 billion above the February 2022 deficit. The deficit for the first five months of fiscal year 2023, at $722.6 billion, is $247.0 billion more than the first five months of the previous fiscal year. In February, government receipts totaled $262.1 billion and $1,735.0 trillion for the current fiscal year. Government outlays were $524.5 billion in February and $2,457.6 trillion through the first five months of fiscal year 2023. By comparison, receipts in February 2022 were $289.9 billion and $1,806.8 trillion through the first five months of the previous fiscal year. Expenditures were $506.4 billion in February 2022 and $2,282.4 trillion through the comparable period in FY22.
- Inflation/consumer spending: Inflationary pressures continued to mount in February. According to the latest Personal Income and Outlays report, the Personal Consumption Expenditures Price Index increased 0.3% in February and 5.0% since February 2022. Prices excluding food and energy also advanced 0.3%, following increases of 0.5% in January and 0.4% in December. Prices for goods rose 0.2%, while prices for services increased 0.3% in February, with prices for food rising 0.2%, although prices for energy fell 0.4%. Since February 2022, consumer prices for food increased 9.7% and energy prices rose 5.1%. Personal income rose 0.3% in February, while disposable personal income increased 0.5%. Consumer spending rose 0.2% in February after climbing 2.0% the previous month.
- The Consumer Price Index rose 0.4% in February after increasing 0.5% in January. Over the 12 months ended in February, the CPI advanced 6.0%, down from 6.4% for the year ended in January. Excluding food and energy prices, the CPI rose 0.5% in February and 5.5% over the last 12 months. Prices for shelter, up 0.8%, were by far the largest contributor to the February CPI increase, accounting for nearly 70.0% of the overall advance. In February, food prices rose 0.4%, while energy prices decreased 0.6%. For the 12 months ended in February, energy prices increased 5.2%, food prices rose 9.5%, and prices for shelter advanced 8.1%.
- Prices that producers receive for goods and services fell 0.1% in February after advancing 0.3% (revised) in January. Producer prices increased 4.6% for the 12 months ended in February after rising 5.7% (revised) for the 12 months ended in January. In February, the PPI index saw prices for both goods (-0.2%) and services (-0.1%) decrease. Producer prices less foods, energy, and trade services rose 0.2% in February after increasing 0.5% in the previous month. Prices less foods, energy, and trade services advanced 4.4% for the year ended in February, unchanged from the 12 months ended in January.
- Housing: Sales of existing homes increased for the first time in thirteen months after vaulting 14.5% in February. Despite the increase, existing-home sales dropped 22.6% from February 2022. According to the report from the National Association of Realtors®, home buyers took advantage of any interest rate declines, while some areas of the country saw gains where home prices declined. The median existing-home price was $363,000 in February, higher than the January price of $361,200 but slightly lower than the February 2022 price of $363,700. Unsold inventory of existing homes represents a 2.6-month supply at the current sales pace, marginally lower than the January supply of 2.9 months. Sales of existing single-family homes rose 15.3% in February but were down 21.4% from February 2022. The median existing single-family home price was $367,500 in February, up from $365,400 in January but lower than the February 2022 price of $370,000.
- New single-family home sales advanced in February, climbing 1.1% and marking the fourth consecutive monthly increase. However, sales are down 19.0% from February 2022. The median sales price of new single-family houses sold in February was $438,200 ($426,500 in January). The February average sales price was $498,700 ($479,800 in January). The inventory of new single-family homes for sale in February represented a supply of 8.2 months at the current sales pace, down marginally from the January estimate of 8.3 months.
- Manufacturing: Industrial production was unchanged in February, following a 0.3% increase in January and a 1.4% drop in December. Manufacturing increased 0.1% in February (1.3% in January) but was 1.0% below its year-earlier level. Mining decreased 0.6%. Utilities, on the other hand, rose 0.5% over the 12 months ended in February, total industrial production was 0.2% below its year-earlier level.
- February saw new orders for durable goods decrease 1.0% after increasing 5.0% in January. Durable goods orders have declined two of the last three months with the January decrease. Excluding transportation, new orders were virtually unchanged. Excluding defense, new orders decreased 0.5%. Transportation equipment, also down three of the last four months, drove the decrease, falling 2.8%.
- Imports and exports: February saw import prices edge down 0.1%, following a 0.4% decline in January. Import prices have not advanced since June 2022, with the exception of a 0.1% increase in December. Prices for U.S. imports declined 1.1% over the past year, the first 12-month decrease since December 2020, and the largest year-over-year drop since September 2020. Import fuel prices decreased 4.9% in February for the second consecutive month. Those are the largest monthly drops since September 2022, and import fuel prices have not risen on a one-month basis since June 2022. Nonfuel import prices climbed 0.4% in February after advancing 0.2% in January. Nonfuel import prices advanced 0.2% from February 2022. Export prices rose 0.2% in February, after rising 0.5% in January. Those are the first monthly increases in export prices since June 2022. Despite the advance, exports declined 0.8% over the past 12 months, the first year-over-year decrease since the period ended November 2020.
- Trade activity weakened in February. The international trade in goods deficit was $91.6 billion in February, up $0.5 billion, or 0.6%, from January. Exports of goods for February were $167.8 billion, $6.7 billion, or 3.8%, less than January exports. Imports of goods were $259.5 billion in February, $6.2 billion, or 2.3%, below December. The February decrease in exports reflected declines in most major categories, with autos falling 11.9% and consumer goods down 4.6%. In February, auto imports were down 7.1%, while imports of consumer goods contracted 5.6%.
- The latest information on international trade in goods and services, released March 8, is for January and shows that the goods and services trade deficit was $68.3 billion, an increase of 1.6% from the December deficit. January exports were $257.5 billion, 3.4% higher than December exports. January imports were $325.8 billion, 3.0% more than December imports. For the 12 months ended in January, the goods and services deficit decreased 21.9%. Exports increased 13.3%, while imports increased 3.5%.
- International markets: The battle against rising inflation remained at the forefront for most of the world’s economies. Core inflation (excluding food and energy prices) hit a record high in the eurozone for March. The European Central Bank hiked interest rates 50.0 basis points and will likely call for a similar rate increase in May. The Bank of England added 25.0 basis points to its target interest rate after inflation in February (10.4% annual increase) exceeded the bank’s expectations. On the other hand, inflation in Canada eased in February, falling 0.7 percentage point to an annual rate of 5.2%. Likewise, Japan’s Consumer Price Index fell a full percentage point to 3.3% in February, bolstered by government subsidies for electricity and natural gas. However, food prices continued to rise. For March, the STOXX Europe 600 Index lost 1.4%; the United Kingdom’s FTSE dropped 3.9%; Japan’s Nikkei 225 Index gained 0.4%; and China’s Shanghai Composite Index fell 1.7%.
- Consumer confidence: The Conference Board Consumer Confidence Index® increased in March to 104.2, up from 103.4 in February. The Present Situation Index, based on consumers’ assessment of current business and labor market conditions, decreased to 151.1 in March, down from 153.0 in the previous month. The Expectations Index — based on consumers’ short-term outlook for income, business, and labor market conditions — ticked up to 73.0 in March from 70.4 in February. According to the Conference Board’s report, an Expectations Index reading below 80.0 could signal a recession within the next year. It has been below this level for 12 of the past 13 months.
Eye on the Quarter Ahead
The second quarter is likely to see interest rates continue to be pushed higher by the Federal Reserve. However, rate hikes may be smaller, with the possibility of a reduction in the number of increases. The labor sector should remain solid, although job gains may wane some. Industrial production may actually show some gains, while the services sector is more likely to strengthen.
Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI, Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities and other bonds fluctuates with market conditions. Bonds are subject to inflation, interest-rate, and credit risks. As interest rates rise, bond prices typically fall. A bond sold or redeemed prior to maturity may be subject to loss. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 largest, publicly traded companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. The U.S. Dollar Index is a geometrically weighted index of the value of the U.S. dollar relative to six foreign currencies. Market indexes listed are unmanaged and are not available for direct investment.
SECURE 2.0 Act of 2022: Rethinking retirement savings
The SECURE 2.0 Act is now law. The legislation provides a slate of changes that could help strengthen the retirement system—and Americans’ financial readiness for retirement. The law builds on earlier legislation that increased the age at which retirees must take required minimum distributions (RMDs) and allowed workplace saving plans to offer annuities, capping years of discussions aimed at bolstering retirement savings through employer plans and IRAs. While SECURE 2.0 contains dozens of provisions, the highlights include increasing the age at which retirees must begin taking RMDs from IRA and 401(k) accounts, and changes to the size of catch-up contributions for older workers with workplace plans. Additional changes are meant to help younger people continue saving while paying off student debt, making it easier to move accounts from employer to employer, and allowing people to save for emergencies within retirement accounts.
Here are eight things SECURE 2.0 changes:
For people in or near retirement
1. Big changes to RMDs. The age at which owners of retirement accounts must start taking RMDs will increase to 73, starting January 1, 2023. The current age to begin taking RMDs is 72, so individuals will have an additional year to delay taking a mandatory withdrawal of deferred savings from their retirement accounts. Two important things to think about: If an individual turned 72 in 2022 or earlier, the person would need to continue taking RMDs as scheduled. If the individual is turning 72 in 2023 and has already scheduled a withdrawal, the individual may want to consider updating the withdrawal plan. Good to know: SECURE 2.0 also pushes the age at which RMDs must start to 75 starting in 2033.
Starting in 2023, the steep penalty for failing to take an RMD will decrease to 25% of the RMD amount not taken from 50% currently. The penalty will be reduced to 10% for IRA owners if the account owner withdraws the RMD amount previously not taken and submits a corrected tax return in a timely manner.
Additionally, Roth accounts in employer retirement plans will be exempt from the RMD requirements starting in 2024.
And beginning immediately, for in-plan annuity payments that exceed the participant’s RMD amount, the excess annuity payment can be applied to the following year’s RMD.
Individual Turning 72 in 2023?
Individuals should consider when to take the first RMD: Either by December 31, 2024, or delay until no later than April 1, 2025. Remember, if the individual delays the first RMD to April 1, 2025, the person will need to take 2 RMDs in 1 tax year: The first by April 1, 2025, which satisfies the required withdrawal for 2024, and the second by December 31, 2025, which satisfies the required withdrawal for 2025.
2. Higher catch-up contributions. Starting January 1, 2025, individuals ages 60 through 63 years old will be able to make catch-up contributions up to $10,000 annually to a workplace plan, and that amount will be indexed to inflation. (The catch-up amount for people aged 50 and older in 2023 is currently $7,500.)
One caveat: If the individual earns more than $145,000 in the prior calendar year, all catch- up contributions at age 50 or older will need to be made to a Roth account in after-tax dollars. Individuals earning $145,000 or less, adjusted for inflation going forward, will be exempt from the Roth requirement.
IRAs currently have a $1,000 catch-up contribution limit for people aged 50 and over. Starting in 2024, that limit will be indexed to inflation, meaning it could increase every year, based on federally determined cost-of-living increases.
3. Matching for Roth accounts. Employers will be able to provide employees the option of receiving vested matching contributions to Roth accounts (although it may take time for plan providers to offer this and for payroll systems to be updated). Previously, matching in employer-sponsored plans were made on a pre-tax basis. Contributions to a Roth retirement plan are made after-tax, after which earnings can grow tax-free.
Important to know: Unlike Roth IRAs, RMDs from an employer-sponsored plan are required for Roth accounts until tax year 2024.
4. Qualified charitable distributions (QCDs). Beginning in 2023, people who are age 70½ and older may elect as part of their QCD limit a one-time gift up to $50,000, adjusted annually for inflation, to a charitable remainder unitrust, a charitable remainder annuity trust, or a charitable gift annuity. This is an expansion of the type of charity, or charities, that can receive a QCD. This amount counts toward the annual RMD, if applicable. Note, for gifts to count, they must come directly from their IRA by the end of the calendar year. QCDs cannot be made to all charities.
For people years away from retirement
5. Automatic enrollment and automatic plan portability. The legislation requires businesses adopting new 401(k) and 403(b) plans to automatically enroll eligible employees, starting at a contribution rate of at least 3%, starting in 2025. It also permits retirement plan service providers to offer plan sponsors automatic portability services, transferring an employee’s low balance retirement accounts to a new plan when they change jobs. The change could be especially useful for lower-balance savers who typically cash out their retirement plans when they leave jobs, rather than continue saving in another eligible retirement plan.
6. Emergency savings. Defined contribution retirement plans would be able to add an emergency savings account that is a designated Roth account eligible to accept participant contributions for non-highly compensated employees starting in 2024. Contributions would be limited to $2,500 annually (or lower, as set by the employer) and the first 4 withdrawals in a year would be tax- and penalty-free. Depending on plan rules, contributions may be eligible for an employer match. In addition to giving participants penalty-free access to funds, an emergency savings fund could encourage plan participants to save for short-term and unexpected expenses.
7. Student loan debt. Starting in 2024, employers will be able to “match” employee student loan payments with matching payments to a retirement account, giving workers an extra incentive to save while paying off educational loans.
8. 529 Plans. After 15 years, 529 plan assets can be rolled over to a Roth IRA for the beneficiary, subject to annual Roth contribution limits and an aggregate lifetime limit of $35,000. Rollovers cannot exceed the aggregate before the 5-year period ending on the date of the distribution. The rollover is treated as a contribution towards the annual Roth IRA contribution limit.
While SECURE 2.0 provides increased opportunities to save for retirement, everyone’s financial situation is different. As always, individuals should consult with their financial advisor or tax professional to understand how SECURE 2.0 changes apply to them.
The information contained herein is as of the date of its publication, is subject to change, and is general in nature. Such information is provided for informational purposes only and should not be considered legal, tax, or compliance advice. Fidelity Institutional® does not provide financial or investment advice. Fidelity Investments (“Fidelity”) cannot guarantee that such information is accurate, complete, or timely. Federal and state laws and regulations are complex and are subject to change. Laws of a specific state or laws that may be applicable to a particular situation may affect the applicability, accuracy, or completeness of this information. This information is not individualized, is not intended to serve as the primary or sole basis for your decisions, as there may be other factors you should consider, and may not be inclusive of everything that a firm should consider in this type of planning decision. Some of the concepts may not be applicable to all firms. Always consult an attorney, tax professional, or compliance advisor regarding your specific legal, tax, or regulatory situation.
Investing involves risk, including risk of loss.
Our View on the Silicon Valley Bank Collapse: What’s Next?
Silicon Valley Bank (SVB), one of the 20 largest banks in the U.S. in terms of assets, has collapsed. It was the second largest bank failure in U.S. history. As well, another (slightly) smaller bank, Signature Bank (ticker: SBNY) folded in similar fashion. In the case of both banks, the Federal Deposit Insurance Corporation (FDIC)—an independent agency of the U.S government that provides insurance to bank depositors—was appointed as the receiver. Put simply, FDIC took over these troubled financial institutions, with the intention to create the best outcome for bank depositors.
The SVB/Signature story has a lot of moving parts, but ultimately boils down to an old-fashioned bank run. A flood of withdrawals from depositors destroyed these banks. How could this happen? Ultimately this type of situation, while complex-sounding, is fairly simple: there were not enough cash and liquid assets available that could be sold to fund deposit outflows, without wiping out their equity capital base. That’s in part because banks are not forced to carry enough cash to fund 100% of their deposits. According to regulations, they’re allowed to invest multiple dollars (think $10, in round numbers) for every dollar of deposits. These investments, which could be in the form of loans to customers or invested in marketable securities such as U.S. Treasuries or Mortgage-Backed Securities (MBSs), are generally longer-term in nature, and are not always able to be sold or otherwise harvested at a profit.
Comparisons have been made to gym memberships; if every gym member showed up at the same time, not everybody can get a workout in. Banks are similar in this respect, if every depositor wants their money back at the same time, not everyone can get their money back.
Why is SVB Unique?
For SVB in particular, the growth trajectory of its deposit base, the concentration of its customers, the peculiarity of its portfolio, and the relative lack of risk controls around the portfolio are fairly unique factors. Per public filings, SVB’s deposit base jumped from $49 billion at the end of 2018 to $189 billion at the end of 2021. Venture capital funding was at all-time highs during this period and start-ups receiving funding were often putting the proceeds into SVB bank accounts. Putting that growth in perspective, SVB’s deposit base grew by approximately 57% per annum in this period while industry deposit growth was only 12% per annum, according to Morningstar’s research. As well, close to half its deposit base originated from technology companies, the majority of which was from early-stage technology companies. Traditional retail deposits, which tend to be stickier and tend to be smaller than the $250,000 insured by the FDIC, comprised a relatively small portion of SVB’s depositor base, making it more prone to a bank run.
As deposits grew rapidly at SVB, it increasingly purchased fixed-income investments. The bonds they purchased (predominantly mortgage-backed securities) were high-quality, but were long in duration, with the weighted average maturity over 10 years. Shortly after making these investments, the Federal Reserve began one of their most aggressive rate hiking periods in history. As interest rates rose, the value of these bonds fell. While in theory, the bond losses only existed on paper (if SVB held the bonds until maturity, they would get all their money back, plus interest), the “mark-to-market”, or unrealized, losses from these investments were significant, exceeding the company’s tangible equity capital. Observing this, depositors became skittish, started redeeming their money, and SVB became a forced seller of many of those bonds to meet redemptions. The paper losses turned into actual losses and laid the foundation for the rush to the exit by SVB’s depositors.
Is This a Lehman Moment?
While the collapse of another bank (Lehman Brothers) was at the epicenter of the Great Financial Crisis of 2008, we believe that the recent bank failures are significantly less likely to trigger a global banking crisis. The speculative excesses that caused the Global Financial Crisis of 2008/09 were rooted in an economy-wide bubble in real estate market, propelled by a large amounts of cheap debt funding that flowed into real estate securities. These leveraged and insufficiently capitalized owners of real estate securities created a fault line in the financial system, causing a global banking crisis as the price of real estate assets started declining and levered investors faced margin calls.
This time around, the speculative excess appears to have been in concentrated in niche segments of equities and alternative asset markets such as companies related to crypto currencies. Unlike the economy-wide debt binge that dominated the period leading up to the GFC, venture capital tends to be equity funded. Consequently, if venture companies fail, the loss typically ends with the investor, rather than being transmitted through the financial system as a bad debt. Additionally, bank balance sheets are, largely a function of the regulatory response to the GFC, significantly stronger than they were in the period leading up to 2008.
We’d argue that while the rapid rise in treasury yields has caused some short-term losses for the banking industry that are substantive, industry capital levels are better positioned to weather the storm. We also believe the regulatory response from the Federal Reserve, the FDIC and the U.S. Department of the Treasury has been quick, unified and substantive. The addressing of insured and uninsured depositors at SVB and Signature, as well as the opening of a borrowing window for short-term collateralized funding available at very attractive interest rates and terms should head off any concerns around systemic risk of a collective “run on the bank” moment.
So, What? Let’s Cover the Investment Implications
First, let’s cover portfolio exposure to Silicon Valley Bank, or SIVB. This stock was listed on the NASDAQ stock exchange so was held by many investors. Some indirect exposure is therefore likely for investors that hold a diverse portfolio using mutual funds or exchange-traded funds. In the case of Morningstar’s managed portfolio range, we expect the maximum exposure to be less than 0.5%, often far less, depending on the strategy used.
Regarding knock-on effects, in the short-term, we’d not be surprised to see market volatility remain elevated, reflecting the increased uncertainty around potential outcomes. In particular, the financial services sector, most notably regional banks, could remain under strain for some time. However, as long-term, valuation-driven, fundamental, and wisely-contrarian investors, this type of setup is one that we’d use to begin searching for opportunities. We’d be looking for our valuation work, coupled with our assessment of fundamental risk and investor expectations, to be our guide in determining whether, when and by how much to increase our investment in the banking industry, as well as other sectors that may potentially be impacted.
As it stands, we have a balanced viewpoint of U.S. financials, with a “medium” conviction rating assigned. From a valuation perspective, the sector looks relatively cheap (the second cheapest, behind communication services) but recent events have increased uncertainty, so careful portfolio construction is warranted. One issue is that the earnings can be quite volatile and cyclical, but bargain prices can present themselves as investors flee from the uncertainty. Armed with research, we stand ready to adapt in this regard and will be looking at both the opportunities and risks very closely.