As in recent years, the beginning of this year gifted us with another shock to the system. This time, the US banking system. While this is not on the scale of Covid or Russia invading Ukraine, it definitely was not in anyone’s top 10 for market predictions. This is a symptom of years of easy money, runaway inflation and a fed reacting at a pace not seen in 30 years. Many have marveled that the economy was humming along, and capital markets were functioning well despite dramatically higher interest rates. That narrative changed with news of a small bank in California, Silicon Valley Bank (SVB), collapsing under the weight of depositors racing to withdraw all their funds.
The principal catalyst for the “run on the bank” was a collapsing crypto market and tumbling technology values. SVB was heavily focused in their lending and deposit taking on this sector. These clients panicked when they heard there may be some issues with the balance sheet and withdrew all their money, seemingly overnight. Ironically, an old-fashioned run on the bank was caused by wildly volatile pockets of technology. It is also ironic that technology shares and crypto “currencies” rallied in the face of these financial difficulties. Meanwhile traditional banks felt fearing contagion, despite how much better managed, diversified and capitalized they were.
From a Canadian perspective we are keeping a close eye on developments, particularly given some Canadian banks exposure in the US. To be clear though, we do not view the current problems in small US regional banks to be a precursor to a 2008 style financial crisis. Rather this is the result of a US financial system that is far too fragmented, under regulated and ultimately far too prone to shocks. Canadian banks proved in 2008 that they can weather the worst financial conditions. While there will be challenges from time to time in the economy which will impact our banks, the system is buttressed by its simplicity and well capitalized banks. Easier to manage and regulate 5 or 6 large Canadian banks compared to hundreds of US banks.
Where we do see risk going forward continues to be in the technology sector. The first quarter saw these shares rally with the most volatile names recovering some of their losses from 2022. The rationale, other than traders “buying the dip”, seems fragile. Valuations remain very expensive, and this is exacerbated by higher cost of capital and a slowing economy. These types of rallies often happen when assets are re-pricing, and we remain skeptical it can continue. Other areas of the market to be wary of are private equity and commercial real estate as these have been slow to “re-price” but are susceptible to negative shocks from higher rates due to higher debt levels and a more challenging macro environment.
It seems to be universally acknowledged that a recession is coming in the next 12 months or so as central branks try to throttle inflation. We would not disagree although, it is difficult to guess the timing and magnitude. We do see many areas of the market as both defensively positioned and attractively valued, particularly health care and consumer staples. These also benefit from healthy dividends which provide portfolios with real cash flows in times of price volatility. We are eagerly monitoring our watch list for a selloff which would present opportunities to buy quality companies.
The principal catalyst for the “run on the bank” was a collapsing crypto market and tumbling technology values. SVB was heavily focused in their lending and deposit taking on this sector. These clients panicked when they heard there may be some issues with the balance sheet and withdrew all their money, seemingly overnight. Ironically, an old-fashioned run on the bank was caused by wildly volatile pockets of technology. It is also ironic that technology shares and crypto “currencies” rallied in the face of these financial difficulties. Meanwhile traditional banks felt fearing contagion, despite how much better managed, diversified and capitalized they were.
From a Canadian perspective we are keeping a close eye on developments, particularly given some Canadian banks exposure in the US. To be clear though, we do not view the current problems in small US regional banks to be a precursor to a 2008 style financial crisis. Rather this is the result of a US financial system that is far too fragmented, under regulated and ultimately far too prone to shocks. Canadian banks proved in 2008 that they can weather the worst financial conditions. While there will be challenges from time to time in the economy which will impact our banks, the system is buttressed by its simplicity and well capitalized banks. Easier to manage and regulate 5 or 6 large Canadian banks compared to hundreds of US banks.
Where we do see risk going forward continues to be in the technology sector. The first quarter saw these shares rally with the most volatile names recovering some of their losses from 2022. The rationale, other than traders “buying the dip”, seems fragile. Valuations remain very expensive, and this is exacerbated by higher cost of capital and a slowing economy. These types of rallies often happen when assets are re-pricing, and we remain skeptical it can continue. Other areas of the market to be wary of are private equity and commercial real estate as these have been slow to “re-price” but are susceptible to negative shocks from higher rates due to higher debt levels and a more challenging macro environment.
It seems to be universally acknowledged that a recession is coming in the next 12 months or so as central branks try to throttle inflation. We would not disagree although, it is difficult to guess the timing and magnitude. We do see many areas of the market as both defensively positioned and attractively valued, particularly health care and consumer staples. These also benefit from healthy dividends which provide portfolios with real cash flows in times of price volatility. We are eagerly monitoring our watch list for a selloff which would present opportunities to buy quality companies.