By Pete Biebel, Senior Vice President
Over the past couple months, we have documented our concerns about the current market environment. The jet stream that had been a northern tailwind for stocks early in the year seemed to have shifted to a southerly direction. We have described what aspects in the climate of the market led us to suspect that the weather was going to take a turn for the worse. We saw dark clouds gathering but had no basis to guess what might touch off a tempest of volatility let alone that the SVB bank failure would be the lightning-bolt that would define the beginning of the storm.
As this new week begins, our real concern is whether the events of last week triggered a contagion of doubt, though not specifically doubt about the health of our banking system. The banks overall are financially sound. Yes, there could be runs on a few smaller, regional banks, but that damage is likely to be well contained. It’s a contagion of doubt about the health of the U.S. economy and the stock market that will have a more lasting impact. Investors who had been tempted to put a little sideline cash back into the market might now be more likely to not buy stocks and instead to seek the shelter and safety in short-term fixed-income investments. Investors who had been debating whether to bail out of positions, especially those that had benefited from the early-2023 strength, are more likely to pull the ripcord now. In short, the suddenly higher level of doubt opens the door to a greater likelihood of seeing the sort of steep drawdowns and spikes in volatility that we warned might occur.
The market action in the early part of last week was none too pretty, but things really got ugly as the SVB news began to break. The averages all hit their highs of the week in the first hour or so of trading last Monday. Those early gains all but disappeared by the end of the session. On Tuesday, it was FOMC Chairman Jerome Powell’s congressional testimony that spooked the market, leading to losses between 1% and 2% in the major indices. After wallowing through a mixed session on Wednesday, the averages spiked higher Thursday morning. This epiphany of bullishness followed the revelation that the weekly Initial Unemployment Claims number, at 211,000, was the highest this year. Signs of a slowing labor market inspired hopes that the Fed might soon make some dovish deviations in its hawkish path forward.
Unfortunately, the opening rush of buying that morning was not sustained and the averages peaked before the first hour ended. It was at about that time that the first headlines on the troubles at a relatively large bank began to appear. Just to provide some perspective, SVB Financial Group is the parent company of Silicon Valley Bank, which, depending how one counts, is/was the 16th or 18th largest bank in the country. The bank specialized in being the repository of funding for many tech industry start-ups and venture capital firms. It is/was a rapidly growing bank, with assets doubling in the past few years to well over $200 billion. The trouble is/was that during the pandemic the bank invested much of its reserves in longer-term Treasury securities. The sharp increase in interest rates over the past year caused those securities to decline in market value. But there was no cause for alarm as long as the bank could hold those investments to maturity. After all, these are Treasury bonds; what could go wrong?
In this case, as interest rates rose, the bank’s paper losses on its overly large concentration in long-dated Treasuries increased. Recognizing the danger in this situation, the bank recently sought additional outside investors to shore up its diminishing balance sheet. As word of those efforts spread, so too did the anxieties of the bank’s large depositors. When one after another of those depositors began to withdraw funds from the bank, they unintentionally forced the bank to sell its Treasury holdings at a loss. On Friday, The Wall Street Journal reported that customers of the bank tried to withdraw $42 billion (about a quarter of the bank’s total deposits) on Thursday alone. No doubt every other depositor was trying to do the same on Friday. Per Barron’s, the bank sold $21 billion of Treasuries and mortgage-backed securities, recognizing $1.8 billion in losses on those sales.
The common stock of SVB was trading near $750 per share and its all-time high 15 months ago. Through the course of 2022, as interest rates rose, the stock price sank into the low-$200s but it had climbed back to the low-$300s a month ago. Wednesday’s closing price for the stock was about $268. It opened last Thursday near $175 and ended the day near $106, a one-day loss of about 60%. Pre-opening on Friday, the shares were indicated to open around $40, but before they could open, the FDIC announced that it had taken control of the bank. The shares did not trade on Friday and are unlikely to ever trade again. SVB is the second largest U.S. bank failure ever and the largest since 2008.
That news Thursday morning triggered a rush for the exits across the market. Stock prices of regional banks plunged. The S&P Financials sector fell more than 4%, its worst day in nearly three years. One measure of big bank performance lost more than 7% on Thursday. The major averages all lost about 2% give or take, pushing the S&P 500 Index (SPX) back below its 200-day moving average for the first time in two months. Generally speaking, the sellers plowed their proceeds into safe-harbor vehicles. Buyers bid up bond prices. The price of 2-year Treasury notes in particular spiked higher, dropping their yield by 0.314 percentage point to 4.586%, its largest single-day decline since September 2008.
Stronger Non-Farm Payroll data on Friday morning brought some early weakness, but the averages were able to levitate into positive territory by midday. Continuing weakness in regional bank stocks eventually spread to other Financials and Technology sector members; ultimately the overall market rolled over and sunk deeply into negative territory that afternoon. SPX ended with a 4.55% net loss for the week, nearly eliminating its year-to-date gain. The NASDAQ Composite Index (COMP) was a bit worse at -4.71%, while the Dow Jones Industrial Average (DJIA) was a bit better at -4.44%. U.S. equity sectors were by far the poorest performers on the week. Among the stronger groups were fixed-income sectors, currencies and commodities.
On Friday, SPX initially found support near the 3900 level, but when that level failed midday, the index spent all afternoon below 3900. So, in addition to breaking below its 200-day moving average and stretching further below its 50-day moving average, SPX sank below the important 3900 level for the first time since the early-December slide. Where SPX has now retraced 50% of its October/February rally, COMP has given back a little more than half of its rally. The Thursday/Friday loss in COMP took the index from well above its longer-term moving averages to the furthest it has been below both of them since early-January.
Now that lightning has struck, will the storm pass quickly or are we likely to endure extended damage? There’s no telling the degree to which the contagion might spread among bank stocks. Though, as mentioned above, at this point it doesn’t seem likely to have a long-term impact on that sector. However, the technical deterioration in the market along with the contagion of doubt that the events of last week engendered suggest that we should expect a continuing negative bias in stocks. And it could get messy. Two weeks ago, I speculated that the market established an important intermediate-term top in early-February and pointed out that, with the VIX volatility index near a one-year low, we were overdue for a spike in volatility. In the coming weeks, we should expect large price swings in both directions, but probably with a downward bias.
One potentially positive aspect of the SVB bank failure is that the Fed is much less likely now to hike its benchmark rate by 50-basis points at its March meeting. Until late last week, the odds of a half-point hike had been steadily increasing. Those odds fell to practically zero following the chaos in financials last week. There are no economic reports today, but tomorrow and Wednesday will bring two very significant updates. The market will likely celebrate if either inflation number comes in much softer than expected. But with the market’s current tendency to give up early gains, chasing either a CPI or a PPI celebration rally is probably not a good strategy. The first of this year’s quarterly quadruple expirations of stock and index options and futures will be this Friday.
As I am writing this on Sunday evening, some of the darkest clouds may be dissipating. A joint announcement from the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. should make things go more smoothly on Monday morning. The regulators took measures to guarantee all deposits of SVB and Signature Bank, a second bank that the regulators took control of over the weekend. Stock index futures are showing gains of about 1%.
| Date |
Report |
Previous |
Consensus |
| Monday 3/13/2023 | No Reports Scheduled | ||
| Tuesday 3/14/2023 | NFIB Small Business Optimism, February |
90.3 |
90.3 |
| Consumer Price Index, February, M/M |
+0.5% |
+0.4% |
|
| CPI, ex-Food & Energy, M/M |
+0.4% |
+0.4% |
|
| CPI, ex-Food & Energy, Y/Y |
+5.6% |
+5.5% |
|
| Wednesday 3/15/2023 | Producer Price Index, February, M/M |
+0.7% |
+0.3% |
| PPI, ex-Food & Energy, M/M |
+0.5% |
+0.4% |
|
| PPI, ex-Food & Energy, Y/Y |
+5.4% |
+5.2% |
|
| Retail Sales, February, M/M |
+3.0% |
-0.3% |
|
| Retail Sales, ex-Vehicles & Gas, February, M/M |
+2.6% |
-0.9% |
|
| Empire State Manufacturing Index, March |
-5.8 |
-7.7 |
|
| Thursday 3/16/2023 | Housing Starts, February, SAAR |
1.309mm |
1.315mm |
| Initial Jobless Claims |
211K |
205K |
|
| Continuing Claims | |||
| Philadelphia Fed Manufacturing Index, March |
-24.3 |
-15.8 |
|
| Friday 3/17/2023 | Industrial Production, February, M/M |
0.0% |
+0.4% |
| Consumer Sentiment, March |
67.0 |
67.0 |
|
| Leading Indicators, February, M/M |
-0.3% |
-0.2% |
|
| Quadruple Expiration of Stock & Index Options & Futures |
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market