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Good morning and happy Monday! We had a really significant week of changes in the direction of some data, followed by the failures of two banks over the weekend- Silicon Valley Bank in California and Signature Bank in New York. Respectively, these were the second- and third-largest bank failures in U.S. history. The U.S. Treasury, Federal Reserve, and the FDIC stepped in with emergency measures to support the depositors of those banks, but the economic alarm bells are now ringing loudly now that there are systemic problems affecting the financial sector.
- The Failures of Silicon Valley Bank and Signature Bank
- Unemployment “unexpectedly” ticks up as employment expectations drop
- Volatility is quickly becoming extreme as the market second-guesses the Fed
The Failures of Silicon Valley Bank and Signature Bank
We are monitoring this situation closely and will be following up with a special mid-week article about these two failures as more information becomes available, but here’s what we know as of Monday morning:
- Both banks were heavily involved in the technology sector. Silicon Valley Bank invested heavily in technology startup companies, and Signature Bank was a major supporter of cryptocurrencies.
- Both banks were FDIC insured, which means up to $250k is insured against a bank failure for every depositor. However, in both cases upwards of 90% of their massive amounts of cash on hand were account balances that far exceeded that FDIC insurance cap. This means that many hundreds or thousands of bank customers in both banks were potentially going to lose huge amounts of their deposited money. What panicked Wall Street all weekend was the number of tech companies that would have lost access to enough cash to even meet their expenses this coming week.
- The FDIC, Federal Reserve and the US Treasury stepped in with emergency powers to announce that all depositors in both banks would be fully guaranteed for their bank balances at the time of the bank seizures, but stockholders and unsecured bondholders in the banks would not be bailed out. The banks will be liquidated and their assets sold off, and whatever remains from those assets will go first to pay for the depositors’ funds, then to secured creditors of the bank.
- The US taxpayer won’t pay for these extra depositor protections, at least directly. The FDIC charges all U.S. banks a premium in order to receive the mandated insurance for their deposits, and will increase the premiums on U.S. banks to cover the extra losses. Banks will most likely just raise their service fees to cover that new expense, however, so expect to see some banking fees increase.
- The stated reasons for the banks’ failures are also similar:
- In Silicon’s case, it appears the bank decided over the last few years to park most of its cash reserves in longer-term U.S. treasury bonds. That doesn’t sound terribly risky, except that the Federal Reserve started raising interest rates very quickly last year, which caused the prices of those existing bonds to drop (because new bonds pay more interest than older ones do). When that happens, the prices of old bonds falls, and the longer the bond has to go until it matures, the bigger the drop. The bank apparently also had no stop-loss measures in place, like rate-swaps, options contracts, etc. In short, very little (if any) risk management.
- In Signature’s case, many of the details are still forthcoming, but it appears the bank suffered heavy losses related to its investment in the crypto space, as well as having nearly 25% of its deposits coming from cryptocurrency.
- There may have been some criminal negligence involved, at least at Silicon Valley Bank. Their former CEO Greg Becker (removed on Friday), was also the Chief Financial Officer at Lehman Brothers in 2008, when that bank collapsed and caused catastrophic liquidity and solvency problems at the height of the Great Recession. That he was at Lehman and oversaw that bank’s collapse is not in itself criminal, but we’ve since learned that while CEO of Silicon Valley Bank, Becker did not fill a required position (Chief Risk Officer) for almost all of last year. The one he did install only this past January ended up spending most of her time overseeing the bank’s Diversity and Equity projects. And finally, three of the bank’s officers, including Becker, sold large amounts of the company’s stock in the two weeks before the bank collapsed. We will have to see, in the fallout, whether there are criminal charges coming for Becker or any other officers at either bank. Becker was also, until Friday, on the board of the San Francisco Federal Reserve Bank, and was quietly removed from that position over the weekend.
- The fear from investors and regulators is contagion: banks deposit and invest heavily in each other, so if one bank fails, it may cut off access to deposit money at another, or else affect that bank’s solvency if a portion of the bank’s investment portfolio falls to $0.
- There are reports this morning that three other banks are facing serious solvency issues, as well: First Republic Bank, Pacific Western, and Western Alliance. The shares of all three are trading down significantly this moring. First Republic, for instance, as I write this, is trading down in pre-market over 65%.
What this means to you:
We will have much more to say about the current bank problems in the coming days. Stay tuned. For now, though, the fear of a bank failure is one of the more serious market risks in the United States, as it can become a self-fulfilling prophecy. Like in the movie “It’s a Wonderful Life”, scared bank depositors can cause a “run” on the bank when enough of them all demand their cash back at the same time. Because our banking system uses what is called a fractional reserve system (most of the money in your account is actually being used in loans and other bank investments), a run on the bank creates a problem where the bank can instantly become insolvent and unable to supply all the cash it needs. Banks need the time to unwind their investments in order to return cash to customers in short order. Normally t’s not a problem, because banks have a good idea of how much actual cash comes and goes from their institutions on a regular day, but in the case of a panic-driven run on the bank, the cash will not be instantly available in sufficient quantities. Because banks have to meet reserve and liquidity requirements at all times, it can cause the bank to become insolvent, and therefore must be shut down, in a matter of hours.
The biggest concern at the moment is that all of these banks are what are called “regional banks”, meaning they are fairly small in scope. It may cause bank customers to lose confidence in smaller community and regional banks, and if that happens, we can see further failures of smaller institutions as people flock toward bigger (though not necessarily safer) banks. It’s also causing a huge spike in the price of Bitcoin this morning, which is another subject. Our firm’s general cryptocurrency position is negative – we do not like investments we cannot fairly value at any given time, and in many cases, do not even have basic FDIC or SIPC insurance associated with them. But people spooked by possible bank failures at the moment may turn to crypto, particularly bitcoin, as an imagined “safe haven”. Don’t fall for it.
What you should do right now is move any amount in your bank accounts above the FDIC’s $250,000 insurance limit, to another bank or into a money market fund. We have a great solution for our clients, because all of our custodians offer substantially higher insurance limits on their own cash reserve accounts – over $1,000,000 in all cases. Reach out to us today if you have questions or concerns.
For nVest Advisors Clients:
There is no reason whatsoever to be concerned about this new banking risk for your own account safety. We’ve been anticipating a recession for over a year, and in all cases, our investment models have already been adjusted for what are always “unexpected” panics as the economy winds down. None of our clients have any significant exposure to either the Tech or Financial sectors at this time (you haven’t for more than a year), and all of our account custodians (Charles Schwab, TD Ameritrade, Betterment, ICON, Empower Retirement, and Aspire Retirement Services) are all solvent and running smoothly. All of our client accounts are SIPC insured, all cash balances are FDIC insured for over $1,000,000, and none of our clients have any direct exposure to cryptocurrency in accounts we manage.
Unemployment “unexpectedly” ticks up as employment projections drop
We have seen what may be the start of recessionary layoffs and unemployment increases. We’ve talked earlier about the massive number of announced layoffs in tech, finance, and retail, and already show layoffs in the manufacturing sector. These had not translated yet into unemployment filings because of severance packages and the availability of other jobs still in the marketplace.
That buffer appears to be over now, as unemployment filings “unexpectedly” ticked up last week (second week in a row after a rapidly slowing jobs market at the start of the year):
This sent us up toward more a normal range of unemployment filings, with only 2020-2021 (Covid shutdowns), 2014-2015 (recovery from the Great Recession) being higher over the last decade:
Continuing claims also rose, indicating that it is getting harder to replace the job you lost:
I am confident enough in the stability of the continuing claims to believe we’ve definitely hit bottom and are going to be ticking higher for a measure of time. In a time when we’ve historically started hiring for seasonal jobs, continuing unemployment is running against a decade-long trend at this point.
In addition, the number of hours worked has dropped off dramatically. This may have been a reversal of bad data in January, but it’s definitely showing a drop in the hours being worked across the economy in February:
So where do we go from here? There are a few ways to look at both historical precedent, and leading indicators, to give us some guidance. First. the leading indicators. This is the use of temporary employees to fill the gaps in labor needs by companies. The hiring of temp workers is closely correlated with actual payroll figures at companies (layoffs, in this case), by a few months:
Additionally, simply asking companies what their short-term hiring plans are, will certainly give you a good look at the possibility of future employment. You can see the actual employment numbers (the black line) trends within the range of the red line (hiring plans) very well. Hiring plans are VERY negative at the moment (meaning there are plans to reduce the workforce from current levels), so in all likelihood, actual payrolls will soon drop accordingly.
And finally, in what I consider more than anecdotal macroeconomic evidence, history shows us that rapid hiring sprees have nearly always occurred right before recessions. This makes perfect sense to economists, because recessions are usually caused when the central bank takes actions to “cool off” an economy that was expanding too rapidly to be sustainable.
What this means to you:
We’ve been telling our readers in this space for a year or more that we believe a recession was almost certain. The data is now beginning to reflect that reality. Sadly, recessions always mean some companies fail (see the two big banks, above, for proof of that), and some people will lose their jobs. Having an emergency fund set up before these natural dips in the business cycle is critical. If you have one, we’ll expect you’ll be needing to use it during a layoff situation. Thankfully, all employers pay unemployment insurance in the states they have employees, and those benefits will help, but we have a tough road ahead for many families. Shoring up your investments to avoid unnecessary losses during the coming market volatility, reducing your expenses to bare minimums, and avoiding adding ANY more debt to your situation, is vital.
Because we’re expecting a significant recession ahead, I’ve published just this week an e-book on the Top 7 things you need to do to prepare for a recession. It’s yours for the asking. Just click on the book image to get your copy:
Volatility is becoming extreme as the market second-guesses the Fed.
One of the biggest ways you know that markets are about to face a prolonged change in direction is when volatility goes wild. We’re seeing those kinds of moves last week and today.
To begin with, recent data pointed to the very real possibility that inflation is coming back, and as a result, the market was down most of last week on the concerns that based on this new data, the Federal Reserve will have to raise interest rates higher than the market had been expecting, and holding rates higher for longer than the markets want. This caused most of the stock market drop over the last week, as the markets re-priced in new expecations for the chance of a 0.50% hike at the Fed’s meeting later this month.
Then the bank failures on Friday happened, and the markets suddenly (and violently) reversed course and now expect less than a 0.25% rate increase this month, with many analysts (nearly always wrong, by the way), now actually predicting that the Fed will pause rate hikes, or even pivot and bring rates down:
Two serious problems with this scenario, if it happens:
- Inflation is heading in the wrong direction for a pivot. If the Fed buckles to market pressure and either pauses rates or pivots and lowers them slightly, inflation will likely roar back in an uncontrolled way. We believe the Fed will continue to remain tightly focused that very significant risk, and maintain their tightening stance, even if it is a 0.25% increase instead of the 0.50% the market was expecting last week.
- The real pain always follows the pivot. Looking back at 2008, the Fed pivoted from their rate hikes in the middle of 2007. It took a while, but the stock market made most of its drop after the pivot (another 50% decline) and real estate prices fell a further 24%:
This happens for a number of reasons, but to be brief, the stock market collapse occurs because investors now know that interest rates on bonds have peaked, which means they can now lock in high-interest rates on their “safe” money – for years or even decades – with very little market risk. So, logically, they move money from stocks into long-term bonds.
A pivot also means that the economy has shown signs of instability; that it cannot sustain any further tightening/hiking. Something inevitably breaks. Companies start showing lower profits, jobs are cut, and projections are scaled way back. Investors respond by pulling out of stocks they believe will drop in the short term.
Also, there is what is called a “lag effect” – it takes 9-12 months for every rate change of the Fed to actually be reflected in the economy.
We are at the economic tipping point. We’ve been shouting warnings for over a year. No one knows exactly when a recession will be declared, but we firmly believe most of the larger economies of the world are right at the door of one now. Recessions can take years to recover from, which is why we believe it is vitally important to get your family and business finances ready to weather through such a storm.
We predicted the beginning of a turn in the current market rally last week, and we reiterate that sentiment now. There will always be market movement that moves counter to the economic data because markets are much more short-term focused, and let’s face it: until fear takes hold, greed is the prevailing emotional state of most market participants. We do believe, however, that the recent rally has fully run its course, and there will soon be a strong shift from stocks into safer investment options such as corporate and government bonds. With interest rates this high, getting a 5% or better yield, risk-free is becoming a more and more attractive option for investors concerned about the coming economic uncertainty. Once there is consensus that either the economy is earnestly deteriorating, or the Fed announces the end of rate hikes, the move from stocks to bonds will accelerate.
Whether you are our client or not, you need to consider the broader economy (and much less so the daily market fluctuations) when making investment decisions. The economy is telling us clearly what is coming, and you need to have your investment accounts prepared before that happens.
Just this week, I’ve published an ebook to help you get your finances ready for the recession directly ahead. It’s yours totally free, just for the asking. Just click on the book image to access and download it.
Use these economic reports, and those of others working in this space, to prepare. You can not only avoid much of the pain that is coming, but you might actually profit from it, if your investments are properly positioned, and you’ve done what you can to shore up your business’ and family’s financial situation. If you need help with this, nVest Advisors has amazingly affordable personal financial planning and fiduciary investment management services to help you.
This is what we do for a living, and we’re very happy to partner with you on that endeavor.
Reach out to us for a totally free financial and portfolio checkup today if you’re concerned about where your finances sit for the coming few years, particularly if you are at or approaching retirement age. We’re delighted to offer you our thoughts. You can schedule that time with us below:
Watching This Week:
- Jobs Report
- Service Sector Update