- Contagion.
There’s no question that every tech startup accountant, fund manager and bank analyst will be spending this weekend busily looking over:
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which banks might be next
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who banks with those banks
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and so on
People will be looking for second order effects. For example, roku apparently had 1/4 of their cash with SIBV [1]. Roku needs to pay the bills, so presumably they will draw down faster from other accounts. Who else do Roku bank with? And who banks with that bank?
There are other forms of contagion. If you work for any tech startup in silicon valley, are you going to go through with house purchases, car purchases for the next few weeks etc?
- Velocity
Bear Stearns, Lehman Brothers, and e.g. UK / Iceland bank collapses took months to fully play out. The first Fed emergency meeting was March 2008, the first small bank failure was July 2008 (Indymac bank) and Lehman’s collapse was September.
(Though notably, at that point, things were moving so fast that Merrill Lynch was bought out the same day by BoA, and the Fed bought AIG the day after.)
SIBV and Silvergate went from ‘no news, most people haven’t heard of them’ to ‘bank run by people in the know’ to ‘shutdown’ within 2 days, and mostly on a scale of hours. Indeed many of the people affected by SIBV’s collapse discovered it only on Friday evening as their paycheques didn’t show up.
It reminds me of the ‘15 minute crash’ we saw in October.
Things are going very fast. Another example is that the pace of rate rises we are seeing being much faster than in the past.
I suspect the flow of interesting news will get even faster as banks, their customers, professional investment managers, and the general public, all rapidly lose their feeling of cheery ambivalence to risk.
The media hype cycle has immediately turned to ‘who’s next’ and that will likely be the dominant story in finance for a week or so.
Possible candidates for contagion are those that dumped hard on Thursday and Friday. Presumably, someone knows something. For example: PACW, SBNY, WAL, FRC, MCB, CUBI.
- Knock-on
I suspect we will see margin requirements being increased by brokers and a bit of forced selling as a result. Where would such selling be seen? In the stuff that has the most profit or least loss, I suspect. “Flight from quality”.
Another knock-on. If the market is dangerous, people tend to move to defensives. Finance companies are sometimes seen as a form of defensive (at least, relative to tech and small caps!). But right now, they won’t be. Housing is also not very defensive just now. So I think we will see a relative increase in the valuations of the remaining defensives: food, cigarettes, drinks, pharma, utilities, and defence manufacturers.
What about commodities? Perhaps. The question is: if we plunge into recession, do you want to be holding commodities?
There’s also a question over utilities, if rates keep rising and stay higher for longer, since they tend to be heavily indebted.
We can already see this clearly starting to play out. Consider Friday’s 1-day heatmap (note to future readers - this link will show 'today’s heatmap, so it’s only useful for this post for the next 48 hours or so).
Everything is red except: food, cigarettes, drinks, some retail, oil, defence, pharma, and interestingly: JPM!
- What next?
I am already positioned in developed non-US industrials with low debt, in US pharma (relating to covid, which I think will continue to ‘force large-scale healthcare spending’), and in US short-term government bonds.
I am hoping this combination will be relatively safe and may provide opportunities to rebalance later on.
I suspect pension funds will emerge as a problem globally, just as they did in the UK in September. For the same reason as the UK pensions funds and SIBV. Poor matching of liability needs over time to available assets. As gilts dump, it becomes more and more damaging to meet ongoing liabilities by selling gilts.
I think it might be fruitful to think of other types of company besides pensions and banks, where short-term liability needs are matched with forced sale of gilts purchased in the last few years. Where else might short-term liability suddenly rise, e.g. to cover increased cost of hedging, increased payouts, etc?
I suspect we saw the first Fed ‘splash of cash’ on Friday morning to help soothe the markets. The more cash is splashed, the more inflation will continue to develop as a problem. The central banks of the world are stuck.
Besides the new credit problem, there is still the ongoing problem of inflation, which continues to rage away. The solution to one problem is fuel for the other. And refusing to pick one problem to fix will enable both to grow and become worse. Can’t pick A, can’t pick B, and can’t not pick either.
What if central banks use QE to keep long-term yields down (to avoid immediate bank/pension fund liquidity crises), but use high short-term rates to try to fight inflation?
The steeper the yield curve inversion, the harder it is for banks to turn a profit, as they lend long and borrow short. Bank profitability will be wrecked.
Also, the higher that short-term rates become, the worse it becomes for non-housing credit and for non-US housing markets where variable rate mortgages dominate.
In much of the non-US anglo world, Australia, Canada, New Zealand, Ireland, UK, there are housing bubbles and raging inflation plus a lot of variable-rate housing loans. If they raise rates, inflation falls or steadies, housing markets crash, and companies/pension funds fold. If they don’t raise rates, inflation rises, and we revisit the problem on a larger scale a few months later.
If the banking crisis turns into general ‘who do I trust’ problem/freeze like in 2008, e.g. prisoner’s dilemma, a global debt crisis, then the eurozone is going to revisit the problems of e.g. Austrian/Spanish banks, Deutch Bank, Credit Suisse etc with urgency.
Indeed, Credit Suisse delayed results last week after getting an urgent communication from the SEC:
https://www.cnbc.com/2023/03/09/credit-suisse-to-delay-its-2022-annual-report-after-a-late-call-with-the-sec.html
In a debt crisis, emerging market countries are going to be a source of problems too, where they have borrowed in dollars. As American Credit retracts its vesicular eyes beneath the shell, emerging markets will suffer.
I believe we should all think fast and double-check our plans and portfolio as soon as we can, because everyone else is thinking faster and faster, and events are speeding up.
[1] https://www.cnbc.com/2023/03/10/roku-says-26percent-cash-reserves-stuck-in-silicon-valley-bank.html