According to LPL Research, a lot has changed in the past few weeks, both in terms of expectations for interest rates and lost confidence in the health of the banking system as a result of the sharp rise in interest rates that has led to some things “breaking.” Here we share some thoughts on who’s to blame for the ongoing banking crisis and reiterate how we are telling investors to adjust, or not adjust, their asset allocations in light of ongoing market volatility.
MARKETS ON ALERT
It’s difficult to grasp that just a few weeks ago, the fed funds
futures market had priced the terminal rate at nearly 6%. The market’s hawkish outlook was predicated on the Federal Reserve (Fed) raising
rates amid a still solid economy underpinned by a tight labor market and
consumer spending, but with inflation still above the 2% level that reflects price stability. Now, with continued pressure on both domestic and global
banks, markets are expecting the Fed will be forced to cut rates towards the end of this year as loan growth slows and businesses, particularly small businesses, and consumers find it more difficult to secure loans.
As a result, the broader economy is expected to be negatively affected.
The rapid collapse of Silicon Valley Bank (SVB), followed by continued pressure on regional banks, along with headlines surrounding the struggle to shore up confidence in First Republic Bank (FRC) has the market on alert for other potentially vulnerable banks. The banking stress of the past couple of weeks has put some heavy pressure on the bank-heavy small cap
Russell 2000 Index.
FINGER POINTING: WHO’S TO BLAME? No sooner had news regarding the run on SVB hit the media, generalized fear and panic spread quickly. Depositors mounted a modern- day run on the bank using their smart phones, and over the course of 36 hours, the bank was forced to sell $21 billion of long duration bonds at a loss of $1.8 billion.
The blame was quickly focused on venture capitalists who sent out immediate warnings to their start-up companies to withdraw their funds at once. SVB’s large client base was broadly made up of fledgling technology companies backed by venture capital. It didn’t take long for depositors to exit. A widely followed newsletter that covers the venture capital world, “The Diff,” has also been considered the spark that led to the mass exodus of deposits, when in late February the report indicated that SVB’s debt
-to-asset ratio was 185 to 1, implying that the bank was virtually insolvent.
The underlying culture of the tech world has also come under scrutiny as to how rapidly conclusions were drawn and how instantaneously they were
acted upon.
ASSET ALLOCATION VIEWS In the current environment of elevated volatility and concerns about banks, LPL Research believes tactical investors should still maintain multi-asset allocations at or near benchmark levels with an emphasis on diversification. Within fixed income, LPL Research continues to like the preferred sector to take advantage of attractive valuations with less risk than equities. Within equities, the technology sector looks better to us here, which, along with the Strategic and Tactical Asset Allocation Committee’s (STAAC) recent decision to downgrade healthcare to neutral, suggests limiting the size of any style tilts toward value. The Committee continues to take a wait and see approach on the banks while closely watching the latest developments. Finally, precious metals-related investments warrant consideration on the long side, in our view.
Securities and advisory services offered through LPL Financial, a Registered Investment Adviser. Member FINRA/SIPC. Longleaf Wealth Management Group, LLC and LPL Financial are separate entities.