Tom Cruise was catapulted into stardom for his portrayal of a teenager looking for fun while his parents were away in the movie Risky Business. Running around the house in his underwear while lip syncing Bob Seger was relatively benign, but that turned to greater mischief and Cruise’s character learned is that a little bit of fun can quickly get out of hand. Are parts of our economic system getting out of hand? What can you do to manage your risk and protect yourself?
The biggest story of last week was the volatility around Fed rate path expectations. Equity markets suffered their worst week of the year with the S&P 500 shedding 4.6%, giving up almost all of 2023’s gains. The Dow Jones Industrial Average is now negative on the year while the Nasdaq remains somewhat of a bright spot, being higher by 6.4% despite losing 4.7% last week. The selloff began on Tuesday after Federal Reserve Chair Jerome Powell opened the door to a more rapid pace of rate hikes to reign in resurgent inflation. His comments seemingly increased the odds of a half-point interest rate hike at the Fed meeting next week, versus the quarter point previously expected. Losses deepened on Thursday after Silicon Valley Bank’s (SVB) sudden move to raise cash spooked investors and depositors, sending bank shares reeling. Markets were stunned on Friday after the FDIC’s seizure of SVB, which raised questions about whether serious problems are developing in the financial sector.
Odds of a half-point interest rate hike by the Fed fell sharply on Friday amid labor market data, as well as recession and financial system concerns. The February jobs report showed that more jobs were created than expected, but the unemployment rate moved higher and average hourly earnings growth was cooler than expected, lessening fears of the labor market overheating. While expectations of the next rate hike are now for a quarter-point, risk remains to the upside pending this week’s Consumer Price Index (CPI) report.
The Color of Money
In The Color of Money Cruise plays a young, arrogant pool player alongside a more experienced and wiser character played by Paul Newman. Cruise’s character learns that he needs to curb his ego in order to succeed. Investors often become arrogant, as they did prior to 2022, but markets tend to act very weirdly, which can be very humbling. This perhaps was the case with SVB. Banks “borrow” short-term cheap money – typically deposits – and invest the money at higher rates, either by making loans or buying safe government bonds. SVB focused on venture capital companies and with the brutal sell-off in tech stocks and downturn in valuations of start-up companies, the flow of venture capital has slowed. This means money-losing tech companies are rapidly burning through cash that previously sat on deposit at SVB. In order to cover the outflow of deposits, SVB had to come up with cash quick, or sell some of their government bond holdings. Because interest rates have risen so much (bond prices fall when interest rates rise), these were sold at significant losses. The bank attempted to raise money to cover the losses, but in doing so caused concern amongst depositors, exacerbating the situation since other depositors saw this as a warning and withdrew funds. 87% of the money on deposit at SVB was above the FDIC insurance limit of $250,000 per depositor but the FDIC, in conjunction with the Fed, have devised a plan to backstop all depositors in an effort to provide confidence in the banking system.
SVB was unique as it catered primarily to venture capital companies. Also, as we came to learn over the weekend, SVB did not hedge interest rate risk well. Other banks are likely to fail, but the chances of contagion, or the spread to other institutions, as we saw during the Great Financial Crisis in 2008 are unlikely. This does not rule out other bank runs, especially since most banks are paying very little in interest and significant amounts of money are being moved to money market funds with much better interest rates. There are lessons to be learned from the failure of SVB, including do not concentrate holdings in one sector and hedge primary risks. The easiest way to avoid these risks is to diversify holdings
In addition to a continued focus on the banking sector, this week brings key reports which are considered catalysts headed into the arch Fed meeting the following week. The February CPI will be released on Tuesday with expectations it will remain above 6%; providing justification for the Fed to continue raising interest rates. Producer Price Index (PPI) and retail sales data will be released on Wednesday.
If you would like to learn more different types of risk and how to manage it, join us for our monthly Market Huddle on Monday, March 20th at noon. You can register by clicking here. We would also be happy to discuss ways to manage risk in your portfolio; contact us to discuss your situation in detail. Opportunities remain in the market, but do not risk your retirement and let things quickly get out of hand.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260