It's a Topsy Turvy World

Today, at market open and for the first few hours leading into lunch (ET), N American equity markets were in a massive sell-off mode, with the S&P declining more than 1%, headlines flashing red all over—this time, due to worries about Credit Suisse (“CS”) and its European brethren. EuroSToxx 50 -the largest European equities?- ended the day 3.1% lower, whereas the EuroStoxx banking index declined about 7%. Later today, S&P closed 0.7%, while NASDAQ was flat for the day.

Nonetheless, suddenly our portfolio positioning appears completely out of sync with what has transpired since Wednesday, March 8th, 2023, once Silicon Valley Bank (“SVB”) problems surfaced. With the failure of SVB & Signature Bank, ?and rumours of a bail-out for CS, the short end of the yield curve has shifted dramatically downwards by about 1%, as illustrated in the Figure. In our previous update, we discussed flattening of the yield curve, but not of the kind evidenced by a parallel downshift across the spectrum, as shown in Figure 1.

Source: FactSet – March 15th, 2023

With this downward parallel shift, financials suffer from expectations of lower interest income and the fearful environment surrounding deposit fungibility. A sudden influx of deposits into bigger institutions, like JPM and BAC, allows them to capture a higher spread between deposit rate and UST yield because these banks are not competing to pay higher rates to get those deposits in. However, they will likely have to hold more capital to back these deposits, so we should know how this will probably shake out around April 15th, 2023, during reporting season.

Healthcare stocks like Cigna and CVS suffer because both have health insurance operations backed by bonds. Float income on those portfolios will likely be less than anticipated just a week ago. Although these are solid, investment-grade, blue-chip stocks, the sudden decline in yields has also taken those down.

Commodity stocks have taken a hit too. Trading desks of most Investment Banks use Value at Risk (”VAR”) as an indicator to manage capital at risk. BNP’s decision to unwind positions with CS in Europe could have caused a dislocation in commodity trading positions, impacting VAR-based metrics. Perhaps commodities and commodity stocks sold off to bring VAR-related trading positions in line.

We are in a topsy-turvy environment for managing money. Too many balls are up in the air, even for accomplished jugglers from Cirque Du Soleil. Conservative decision-making has failed to pay – except for the allocation to cash – because a sudden decline in yields lit a fire under NASDAQ, which was the pariah a few weeks ago. Nonetheless,?the mega-cap global tech has the heft and balance sheet strength to outlast any bank run or recession.

For context, Alphabet has $113B of cash on hand, whereas the First Republic Bank – saved by the Fed backstop this week – has $171B in deposits. Its market capitalisation is a mere ?$5.8B. In our opinion, even that valuation, down 80% or more from the peak, is too high, and most regional U.S. banks are falling knives. While the banks may not go under, regional-bank stock investors face a CS-like meandering scenario. We just heard on Bloomberg that First ?Republic is now for sale. In our view, the potential equity value is zero.

What next? We stay conservative, hold our breath, and let the storm pass. Tomorrow morning ECB has a rate decision to announce. Christine Lagarde was adamant about a 50bps rate hike by the ECB, but the events of the last two days might suggest otherwise. Similarly, the CPI index from today is still too hot at 6% YoY.

Could that cause the FED to hike by 25bps and then pause? The point is that suddenly we are entering an environment where rates are high, inflation is high, growth is falling, and liquidity is challenged. I also believe that by providing a deposit backstop, the FED wants to ensure that HH and corporate liquidity do not dry up. That means, by extension, the FED may not want to slow down and that the rate increases will continue apace, to bring inflation under control. We should know Fed’s views on March 22nd

The currently developing narrative and outlook is far worse than our expectations outlined in various columns since the beginning of 2021. In ANTYA's view, we are now setting up for either a long period of suboptimal returns or a sudden significant correction. The odds of either are equal.