That was a tough week.

 

After a pretty good start to the year, equity markets have pulled back toward their 2022 year-end positions on worries of rates and banks and contagion. While our more stable tradition in the Canadian financial system is still in relatively good shape, most of us also have US and global assets in our portfolios -- we all look forward to calmer seas. If there’s a hint of good news so far this year, bonds are behaving better than they did last year, offsetting equities to some extent – which is more or less what they’re for.

 

Head Office Analyses:

• Stress fracture - The collapse of Silicon Valley Bank, and markets’ subsequent loss of confidence in other financial institutions, brought stresses in the financial system suddenly to the surface. But this didn’t happen overnight. We look at the causes, the knock-on effects, and what all of this could mean for the prospects of a U.S. recession and equity market performance.
• Regional developments: An SVB-like event is unlikely to materialize within the Canadian banks; Mixed economic data and banking stress leave the Fed with a difficult decision; ECB hikes interest rates amid banking sector turmoil; China state-owned companies outperforming despite volatile global market environment.

Full Insights here: SVBandCo

 

The Wrong Headline: With all due respect to our colleagues at RBC Global Asset Management, they might have chosen a better title for the graph (below), which is actually an important one. Pandemics don’t cause savings. The transfer from governments to people during covid was probably oversized, and that’s seems to be proven here:

 

 

 

 

I’m also pasting a longish letter from our Portfolio Advisory Group in case you want to read a few additional thoughts on the markets this week.

 

Portfolio Advisory Group Analysis:

It’s been a whirlwind of a week in global markets. Concerns over the stability of the global banking system emerged after a few sudden U.S. bank failures and signs of stress at a larger European one. Policymakers responded quickly and the situation has stabilized, for now. We discuss this below, and reiterate our confidence in the investment outlook for the Canadian banking industry.

 

History has taught us that some investors, consumers, or businesses find themselves caught in a vulnerable position nearly every time financial conditions have tightened. This has largely resulted from complacency or dependence on cheap financing to enhance returns, fund spending, and grow profits. This time appears to be no different. Interest rates began their ascent nearly a year ago and the first signs of challenges emerged within the venture capital industry, as some early stage companies saw their access to low cost capital vanish quickly. A surprise then emerged last fall when the Bank of England stepped in to rescue a number of U.K. pension funds that had their bond portfolios marked down meaningfully as a result of higher interest rates and leverage. More drama unfolded over the past week as a few regional U.S. banks were shut down as a result of a classic “bank run”, in which an overwhelming number of depositors (clients) lost confidence and decided to withdraw their funds.

 

The banks in question this past week shared a combination of attributes: a clientele that was tied to certain industries like venture capital, a disproportionate amount of client deposits that was uninsured, bank assets that were concentrated in fixed income securities like government bonds with unrealized losses due to higher interest rates, and less stringent regulation compared to larger banks. These factors ultimately led to the banks’ demise. The situation in Europe on the other hand is different as the bank in question, Credit Suisse, is significantly bigger and has been plagued by challenges for years.

 

Central banks, governments, and other commercial banks have taken swift action. They announced guarantees of all deposits at the failed U.S. institutions, and injected deposits to other banks in an effort to shore up confidence in the banking system. Moreover, a new lending facility was created to allow U.S. banks to exchange securities like bonds for emergency funds. Meanwhile, the Swiss National Bank has stepped in to lend Credit Suisse a sufficient amount of funds to support it for the time being.

We believe the past week’s events have two near-term implications. First, financial conditions are likely to tighten further as banks prioritize liquidity and capital. This will inevitably weigh on growth as some consumers and businesses may have a more difficult time accessing credit. The second implication is that central banks like the U.S. Federal Reserve may think more carefully about future policy moves as they now have to balance the stability of the financial system along with inflation and growth. That said, the European Central Bank still raised rates over the past week and markets still expect the U.S. “Fed” to do the same once it meets over the coming days.

 

Not surprisingly, shares of the Canadian banks have been volatile as they have moved in sympathy with U.S. and global peers. But, we remain confident in the stability of the Canadian banking industry. Unlike some of the U.S. regional banks, the Canadian banks have a few advantages: a deposit, asset, and customer base that are all very well diversified, elevated liquidity positions, and high capital levels. While heightened regulatory scrutiny over the past few years may have limited the Canadian banks’ profitability, it has left the group better positioned to deal with periods of stress.

 

Should you have any questions, please feel free to reach out.

 

 

Please enjoy your weekend.

Mark