By now, you may have already seen the headlines and with the S&P 500 being down 4.5% last week, we wanted to be sure to provide a timely, plain English response to everything going on.
A little back story: Silicon Valley Bank (SVB) rapidly grew their deposits in recent years and needed a place to park their money. They purchased mostly long duration US Treasury Bonds that were intended to be held to maturity, which are subject to interest rate risk. While interest rates increased over the last 12 months, the value of those bonds fell. SVB's depositors, largely made up of Start-Up Businesses and Venture Capital firms, withdrew deposits to operate their companies during a time when Initial Public Offerings and Private Fundraising was difficult to come by. On Wednesday of last week, SVB announced a Common and Preferred Stock Offering and reported that they sold $21 billion in bonds to raise cash to shore up it’s balance sheet while recognizing a $1.8 billion tax loss.
This created panic among their primary depositors, of which 86% of the banks deposits were above the FDIC (Federal Deposit Insurance Corporation) insurance limits of $250,000 per account registration. This made the bank vulnerable to a run on deposits and on Thursday, $42 billion was withdrawn from the bank, causing the California Department of Financial Protection and Innovation to close the bank on Friday.
On Sunday, Regulators approved plans to protect depositors (not shareholders or management) by making all FDIC insured funds available for withdrawal on Monday while creating a new Bank Term Funding Program to protect institutions affected by the fallout. This allows banks to use assets such as Treasury Bonds as collateral to borrow against at full par value not current market value (or 100 cents on the dollar).
What this means for you
Regardless of whoever you bank with, you’re covered under FDIC insurance (National Credit Union Administration or NCUA for credit unions) for $250,000 per depositor, per bank, per ownership category (individual, joint, corporate, etc). In the event of a bank failure, the FDIC pays insurance within a few days after a bank closing. If your bank fails and you have funds above the insured limit (or significant funds at one bank), it may make sense to keep safe money at multiple financial institutions. This could include high yield savings accounts and money market funds (covered under SIPC). The benefit is these types of accounts can often provide better interest rates on your money than your typical brick and mortar bank. The important thing here is having access to liquid funds readily available to cover payroll, emergencies and operating/living expenses.
From an economic perspective, this could make the Federal Reserve change course. We are expecting a .25% rate hike when the Federal Reserve meets next week, but believe they could change course based on these recent events. Meaning, fewer rate hikes (or even a pause) could happen for the rest of the year with the first rate cut happening at the end of the year and several more in 2024.
The most anticipated recession has been forecasted for some time now with how aggressive the Federal Reserve has been recently. We do feel inflation will continue to fall, we just don’t know how fast. What we do know is that the Federal Reserve tends to overshoot interest rate hikes and we believe if they do hit pause and ultimately cut rates, a market rally may be in our future. Year to date (as of Friday, March 10th), the S&P 500 is +.9%, the Dow Jones Industrial Average is -3.2%, the NASDAQ Composite is +6.6% and the MSCI EAFE (International Index) is +6%.
If this comes to pass, we believe the NASDAQ should outperform the S&P 500 and the S&P 500 should outperform the Dow Jones Industrial Average. If it doesn’t, and we continue to see volatility, dividend paying stocks and high quality intermediate bonds should provide stability to our clients portfolios by providing a nice dividend and bond yield while we wait. Either way, trying to time the market is never a good strategy. Those that do, tend to sell or liquidate when the market is at a low (due to fear) and buy when the market is at a high (due to greed/optimism) and that is the worse thing an investor can do. Often times the best days in the market follow the worse days in the market. As you can see below missing the best days in the market can be detrimental to returns:
More bank failures could be on the horizon, but in the end, we are not predicting systemic failures of our banking system. We do not believe that will happen. There is always something to worry about and this happens to be the flavor of the week. A good long term financial plan includes having at least 3-6 months in savings as well as using money market funds and conservative investment strategies for low-risk money, providing returns that have historically been better than your typical bank checking or savings account. This allows you to ride the stock market rollercoaster in your longer-term growth and income and aggressive growth strategies to help you outpace inflation. Since 1950, the S&P 500 has had an average return of over 11%.
Now, we can't use past performance to predict future results, but what we do know is, volatility is expected. In order to receive market returns over the long term, we need to be able to tolerate an average of 3 market corrections of 5%/year, 1 correction of 10%/year, 1 correction of >15% once every 3 years and 1 correction of >20% once every 6 years (we've actually had two in the last three). Remember, nobody gets hurt on a rollercoaster unless they jump off during the ride.
If you would like to have a conversation about your financial plan and investment strategies, please do not hesitate to reach out. We’d be happy to discuss our long term outlook, your portfolio as well as cash management strategies.