March Market Update

In the wake of regional bank collapses here in the US, many of our clients are asking how these developments could impact their portfolios. Conner Hanlon, CFA , our portfolio manager at Falcon Wealth Advisors , joined Jake Falcon, CRPC? and I to?discuss this news, as well as recent market volatility and what we’re doing for our clients. A summary of our conversation is below.

Jake:?Conner, can you start us off by explaining what happened at Silicon Valley Bank?

Conner:?Sure. A few weeks ago, SVB announced they would have to sell a large amount of bond investments at a loss to create liquidity. They also announced a new stock offering, which would dilute their current stock. Both of these actions spooked investors, who started looking into the bank’s finances. That caused a classic bank run, with SVB depositors rushing to get their money out of the bank.

How did SVB find itself in a situation where it so desperately needed cash? First of all, the average account size at SVB was $1.1 million, which is very large. This is because their customer base was primarily venture capital funds in Silicon Valley. SVB also over-invested in long-term bonds in recent years when interest rates were low. They did this in an effort to secure high-yield returns, but when interest rates rose last year, the value of those investments dropped significantly.

Jake:?Correct, the bank used customers’ deposits to buy bonds that weren’t going to mature for 10 or 15 years, only to see the values of those bonds decrease when interest rose. You’re suggesting the bank mismanaged their investments, correct?

Conner:?Correct, they should have diversified their portfolio by using both short- and long-term bonds, even if yields on those shorter-term bonds were lower. If they would have done that, they probably wouldn’t have found themselves in this position.

Jake:?I’ve found a lot of people don’t fully understand that banks reinvest their money. If you have a lot of money in cash at the bank, not only are you not earning much interest on it, but the bank is likely taking advantage and investing that money to drive their own profits. At?Falcon Wealth Advisors, we would argue that?you?should be the one making money on your cash, not a bank that could potentially become insolvent.

So back to SVB, their customers saw that the bank could be in trouble and started to withdraw their funds, which forced SVB to sell those long-term bonds at a loss, correct?

Conner:?Yes, and in addition, their lending practice was not doing well due to higher interest rates dampening interest in loans. These factors created a recipe for collapse.

Cory:?On a recent episode of?Upticks?titled?Understanding Bonds, we talked about interest rate risk. Because they didn’t diversify, SVB suffered from interest rate risk on both sides of their balance sheet.

Jake:?Many people are aware that the FDIC insures bank customers up to $250,000 on their deposits. But in the case of SVB, I’m sure many readers are now aware that the government?stepped in and announced they would ensure all depositors get back?all?of their funds that were deposited with SVB and Signature Bank. The government has said they did this to prevent a wider industry collapse.

Cory, what are some tips individual investors and?Falcon Wealth Advisors?clients can take away from this situation, as they examine their own banking relationship?

Cory:?One big one is evaluating how much money you have in cash at any one bank. If it’s more than $250,000, let’s talk about how you should handle that situation.

Jake:?And we’re of course talking about actual cash, not the diversified investments our clients have at Charles Schwab, our custodian. Investments aren’t guaranteed, making FDIC insurance a moot point, but even if the company that holds your investments were to go out of business, you would still own the stocks and bonds in your account.

Conner:?That’s correct. It’s important to know where your money is and its coverage. It’s important to check with your?fiduciary wealth advisor?and make sure you have all your bases covered.

Jake:?Indeed. Conner, I know you think the collapse of these regional banks could create a ripple effect. Can you talk about what we’re doing for our clients to protect their investments during this time of volatility?

Conner:?We’re looking at metrics related to banks and trying to identify ones that could be at risk, as we of course want to do everything we can to protect our clients from being invested in a bank like SVB. We’re zeroing in on specific stats like uninsured deposits.

Jake:?On that note, do you think the government’s bailout of SVB depositors indicates they will insure all bank deposits moving forward?

Conner:?If another bank were to collapse in the next few weeks, I think it’s likely the government will make depositors whole. But in the long term, I think we’re going to see new policy changes and regulations.

Jake:?And it’s worth noting it was depositors who were bailed out. Investors who owned SVB stock and bonds took on losses. And as you alluded to, as part of our diversified portfolio, we do buy stocks offered by financial institutions, which is why your team is examining those institutions to confirm they are on steady ground.

Cory:?One final point on SVB. I find the debate interesting around if it was a true bailout. Even though it wasn’t funded directly by taxpayers, I think this was a bailout.

Jake:?Do you two think the government made the right call by making all depositors whole?

Cory:?I’m not sure. I understand why they did it. But they essentially said the $250,000 cap is meaningless.

Conner:?I agree. And I think it could encourage bad behavior and risk taking, as people assume the government will bail them out up to any amount if something goes wrong.

Jake:?It certainly gives the government more power. I feel bad for the depositors, obviously. I wouldn’t want anyone to lose their money because a bank was mismanaged. But I think it’s a good lesson on the importance of being an informed customer and investor. There are a lot of people involved in this situation who should have known better.

Let’s now talk about the market’s performance. It was strong to start the year but has been choppier in recent weeks. As we record this episode in mid-March, do you think this is the domino that could push us into a recession?

Conner:?I do think this could be an inflection point for the market. And I think it could lead to the Fed slowing or ceasing the raising of interest rates, which will be good for the economy in the long term, as we all want to get back to a more normal financial environment. Hopefully by the fourth quarter of this year, we will have a lot more clarity around interest rates. Investors like predictability.

Jake:?I agree with your assessment. We could see more volatility in the first half of this year, but I think things could settle down later in the year, as businesses and investors get more clarity around interest rates. What are your thoughts, Cory?

Cory:?I think it’s interesting to see how bonds have behaved recently. Their yields have decreased while their value increased. Most people invest in bonds as a safe haven, and we’re seeing more and more people wanting to invest in bonds as worries about a recession persist.

Jake:?And this is a good time to remind readers that we invest in stocks for long-term portfolio growth. While we pay close attention to the stock market on a day to day basis, for your financial plan to work,?we buy stocks with the goal of them working for you?over the next 5,10, 20 years. And that’s why we try to help clients invest at least five years worth of living expenses in steadier investments like bonds and cash. Because we’re focused on stock growth over the next decade and not the next month, I don’t think clients should lose sleep over the market’s day-to-day performance. Your financial plan isn’t dictated by what happens today.

Conner, any thoughts as we head into the second quarter of the year?

Conner:?As I mentioned, I think it will be good for businesses to get clarity on interest rates, and I think that will hopefully lead to a calmer market environment. At?Falcon Wealth Advisors, we’ll continue to look for opportunities to grow our clients’ portfolios while mitigating risk.

Cory:?Someone once told me that the ideal time to buy is when you don’t want to. That’s why we will continue to follow our processes and strategies. We’re not making decisions based on our opinions or emotions.

Jake:?Yes, we use math to guide our investment decisions, as we aim to buy low and sell high for our clients. Thanks so much for joining me, Cory and Conner. If you would like to learn more about how our financial planning practice can help you navigate good times and volatile times, please don’t hesitate to contact?Falcon Wealth Advisors. You can reach us directly at?[email protected],?[email protected]?and?[email protected].

Clients choose to work with us to enhance their financial literacy and explain exactly what?their?financial plan means to?them.

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