Eric Sterner, CFA, CAIA, FRM, CIPM
Chief Investment Officer, Apollon Wealth Management
Overview
The past year has been an extremely challenging environment for investors as inflation has risen to historically high levels due to several macroeconomic factors caused by the COVID-19 pandemic. The US Federal Reserve (the “Fed”) as well as other international central banks have raised interest rates at a historically fast pace in efforts to restore price stability. These actions have created heighten volatility in the stock and bond markets as the Fed tries to cool the economy, which, in turn, would help bring inflation back down to normal levels.
With market volatility already high, it further boiled over the past few days with the news of Silicon Valley Bank’s collapse, which was followed by regulators seizing New York regional bank Signature Bank. These two banks represent the 2nd and 3rd largest bank failures in US history. The stock prices for certain regional banks dropped significantly as fears of contagion spread with memories of the subprime mortgage issues which caused the Great Financial Crisis of 2008 – 2009.
So, what happened?
With the top question on investors’ minds of how wide spread these banking issues are, it’s important to review what we know so far:
- Silicon Valley Bank (“SVB”) primarily provided banking services to technology startups, venture capitalists, and cryptocurrency firms.
- The technology sector is very interest rate sensitive. As rates increased over the past year, these startup companies faced greater challenges in raising additional rounds of capital, which required these companies to withdraw existing funds from SVB.
- SVB made poor asset-liability management decisions by investing excessive funds in bonds over the past few years, which lost value as the Fed increased rates. As withdrawal requests increased, so did the need to sell these assets at a loss to the point that SVB became effectively insolvent.
Signature Bank served clients in the cryptocurrency world. The bank was attempting to reduce its exposure to cryptocurrencies after the collapse of the crypto exchange FTX. As consumers became more concerned about banks with crypto exposure following the SVB collapse, withdrawal requests at Signature Bank spiked so high that it could no longer operate.
These two banks served a very niche client base and there is no evidence that their failures will spread to other banks. Other banks are typically more diversified across industries, customer bases, and geographies. Additionally, the most recent round of “stress tests” by the Fed of the largest banks and financial institutions showed all of them would survive a deep recession. Of course, we will be closely monitoring this situation as the current economic environment with heightened inflation and interest rates has created challenges for most companies (and consumers).
What does this mean for investors?
Some people may attempt to put partial blame on the Fed for its aggressive rate hikes. There were fears the Fed’s rapid series of rate increases would eventually “break something” within the financial system. I’m not one of those people. The Fed did make a mistake in 2021 by labeling inflation as “transitory” and not increasing rates sooner. However, with that mistake behind us, I believe the Fed is taking proper steps now by aggressively raising rates to combat inflation. Runaway inflation can cause severe damage to a country’s economy in the long run.
These collapses were caused by poor management decisions within those banks where risk mitigation strategies could have avoided these collapses. Market volatility will most likely remain heightened in the coming months as more details emerge and the Fed continues its efforts to tame inflation. Bear markets and specific company financial shocks can cause great investor anxiety. It’s important to not let emotions dictate your financial decisions and to remain disciplined to your investment plan.
Apollon Wealth Management, LLC (Apollon) provide advice and make recommendations based on the specific needs and circumstances of each client. For clients with managed accounts, Apollon has discretionary authority over investment decisions. Investing involves risk and clients should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing price to make decisions. The information contained herein is intended for information purposes only, is not a recommendation to buy or sell any security and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances.
