This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.
We also provide regular webinars called “Making Sense of Markets” where they discuss the factors affecting economies and markets. Our latest recording was on Friday, 3rd February 2023. Please click here to watch the recording the webinar.
In this latest article we comment on the recent events surrounding the collapse of Silicon Valley Bank and the potential to investment markets.
Bank Collapse
Silicon Valley Bank (SVB), a medium sized US bank which specialised in servicing the technology sector, collapsed on Friday as depositors rushed to withdraw their funds, concerned over huge losses the bank had incurred in its holdings of long dated bonds.
Losses in Bonds
Typically a bank’s core activity is to pay relatively low interest rates on deposits and to charge relatively higher interest rates on the loans it makes. Another potential way to profit from the deposits is to invest in high quality securities, such as bonds, and earn the income these pay. SVB was heavily exposed to the latter. As interest rates have increased rapidly over the past 12 months, bonds have fallen heavily in value. Consequently, SVB saw the value of its assets (the bonds held) plummet, while it’s liabilities (the deposits held) were expecting higher interest rates to be paid out. As this situation become widely appreciated, concerns over the bank’s profitability grew, and a run on the bank ensued.
Reassurance
On its own SVB is small enough not to be systematically important, and further reassurance has come over the weekend with authorities pledging to protect all US deposits and with HSBC buying out the UK arm of the firm. Therefore the bank’s customers will avoid major losses, sparing the tech industry from a spate of corporate collapses. As such, a small market reaction would have been justified if the implications spread no further.
Banks in Good Health
Yet, there have been fairly significant movements in markets since this story emerged with global stocks, particularly banks, falling, while government bonds are rallying strongly. While there are a number of other smaller banks which appear vulnerable in a similar fashion to SVB, most analysis so far suggests that the majority of banks, and particularly the well-known, global banking groups are well placed to handle this issue. While these banks will have experienced losses on their bond holdings over the past year, most have a much smaller proportion of their assets here, instead with a preference for the traditional practice of using to deposits to make loans. With the higher rates charged on loans than paid on deposits, higher interest rates should enhance banks’ profitability, rather than denting it (as SVB found with bond investments). In theory therefore, the majority of the banking sector should not struggle in the same way that SVB has.
Assessing the Situation
Theory and practice do not always align however, and traders and analysts are currently nervous of whether any other banks are vulnerable. What we are currently experiencing in equity markets is therefore panic while the situation is assessed. Robert Armstrong, a columnist for the FT summed up the situation as “SVB is not a canary in the banking coal mine” but that the situation is more akin to “shouting fire in a crowded theatre”. Only time will tell whether there are further large scale threats to the banking sector, but for now this does not appear to be the case.
Changing Interest Rate Expectations
While movements in equity markets have been negative (moderately), in government bond markets prices are rallying strongly. While interest rates have risen by large amounts over the past year, markets were still expecting more to come, especially so in the US. The crisis surrounding SVB is a reminder that there are costs to stability from higher interest rates. In the UK we saw an example of this in late September, with pension funds struggling as Liability Driven Investing came unstuck and now we have seen these unintended consequences emerge in the US. This is likely to make central bankers more cautious of aggressive tightening for fear of what other issues may develop. As such market expectations for near term interest rate rises have shrunk dramatically. As with the equity markets, today’s movements have the sense of a knee jerk reaction, while the facts of the matter are yet to be clarified. With a little time, calmer assessments may emerge which go on to unwind some of the moves we are currently seeing, but until that emerges volatility is likely to remain high.
Likely Contained
Higher interests are designed to make business more difficult and while the current example is an extreme occurrence, it is not overly surprising that there are to be some causalities from such aggressive central bank action. Banking stocks are likely to remain vulnerable until more confidence emerges in the assessment of their profitability, but this may not take too long with markets already stabilising after their initial falls. In summary, it seems likely that this situation should settle to being a relatively contained incident with few systematic implications. Nonetheless, caution and careful monitoring should be maintained.
Our Philosophy
Volatility is a part of investing which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fair better in different market conditions as they are more defensive assets such as bonds, whereas during periods of growth equities tend to fair better.
Armstrong Watson, in addition to our full range of accountancy services, also have our own fund management expertise from the Future Money asset management team, as well as independent expertise from the wider market. We are able to use this to help provide insight, commentary, advice and support to our financial planning and wealth management clients.
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Important Information
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.
If you would like to discuss your investment portfolio please speak with one of our Financial Planning Consultants on 0808 144 5575 or email us.
