What a change one weekend has wrought! On Friday, Silicon Valley Bank failed as depositors headed to the exits believing – correctly, as it turns out – that bank management had invested short-term cash deposits in longer-term treasuries at a time of rising rates resulting in negative returns. Signature Bank followed, and panic ensued.
In the last 48 or so hours, much has changed.
• The Fed backstopped all deposits, leaving the shareholders and bondholders of the banks to absorb the losses.
• Pieces of SVB have been sold off.
• Monday morning, bank equities generally traded off with a stoppage in trading, but as of 11am the freefall seems to have stopped.
At this moment, we are not overly concerned about the safety of the banking system nor the markets in general, and indeed see a buying opportunity in certain sectors.
Over the weekend, we jumped in to understand our exposures. We contacted our private investment partners, especially those focused on venture capital.
> Prior to the Fed’s announcement on Sunday, most of our general partners and their underlying companies had minimal risk to Silicon Valley Bank.
> As of Monday morning, with the Fed announcement of its financial system backstop, it appears all deposits are secured, halting negative ripple effects on small to mid-size financial institutions which could have been detrimental to many small businesses across the country.
After all this kerfuffle, our near-term thought on the Market is that we are Aggressively Going Nowhere. There has been a solid 8% -9% rebound in the first half of the first quarter of 2023. The Market is pricing in that the Federal Reserve has been too aggressive with their interest rate moves over the last 12 months. High rates have broken parts of the banking system, and the Fed still has to produce 2-3 million new unemployed households soon to further slow inflation. In fairness, the failure of the banks over the weekend is also a result of poor risk management by some banks and the lack of oversight by our bank regulators, resulting in a mismatch in duration risk due to the Fed’s extreme interest rates hikes from 0% to 5% in fewer than 18 months. These are complicated issues, and if you’re not confused you don’t understand what’s going on, but rest assured that all parties are at fault.
Why didn’t the Fed see these issues? We believe that they had blinders on with regard to two data points arising out of the Pandemic:
• persistently high employment, and
• the amount of savings Americans still hold from the helicopter money of 2020 / 2021.
These factors combined to create outsized demand on a broken supply chain causing high inflation. The Fed cannot fix the supply chain issues, but they do believe they can control employment and money supply (M2 or personal savings).
When we peel back the onion, we see signs of the economy breaking. Credit card debt is quickly climbing to all-time highs. New mortgage applications are at 28 year lows. The car industry in trying to figure out how to restructure and become more profitable (see GM offering early retirement packages to 88,000 white collar employees). And several banks failed over the weekend due to rapidly rising rates creating a duration mismatch in their investments.
> All in all, we believe the Fed's hawkish inclination to continue lifting rates has us on a verge of, if not already in, a recession.
> The Fed continues to tighten without letting prior rate increases work their way through the system and we are or will soon experience the logical, inevitable outcome of what Milton Friedman referred to as the “long and variable lags” in monetary policy.
So, we will not be surprised to see the Fed stop rate increases within the next 60 days or so. Dis-inflation is at hand driven largely by reduced lending by banks of all sizes, taking more liquidity out of the market, as well as slowing employment and eventual rises in unemployment.
Ironically, our portfolio positioning hasn’t changed.
o We continue to hold larger allocations of cash and short term US Treasuries. When these TBills mature, we will decide whether to roll the maturities out another 12 -24 months to lock in near-term tops in rates or to add to Large Cap and Small Cap US equities.
o We expect the equities markets will rebound prior to the economy bottoming, and this could happen sooner than later and very quickly.
o We continue to favor natural resources, specifically cooper and oil, as long term investments.
o And we look to our dividend-paying equities, private credit and private real estate investments to provide cash flow while we wait for our investments in private equity and venture backed companies to mature.
Our views may seem contrary to the current news cycle. Well, they are! And we hope we’re correct. If not, however, our positioning still preserves capital and generates cash returns which support family lifestyles.
We welcome your thoughts and treasure your friendships and trust.
Warmest early Spring regards,
Jeff & Biff
CrossGrain Family Investments, LLC (CrossGrainFI) is a Federally-Registered Investment Adviser. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Please contact us at 804.217.2561 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from CrossGrainFI with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on the SEC website, https://adviserinfo.sec.gov. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.