The ETF Portfolio Strategist: 12 MAR 2023

Trend Watch: Global Markets & Portfolio Strategy Benchmarks

If there’s an opportune moment to jettison the cautious outlook that’s featured on these pages in recent months, this isn’t one of them.

Granted, a banking collapse at the center of the Silicon Valley tech economy isn’t pivotal for managing a global, multi-asset-class portfolio. But the second-biggest bank failure in US history, triggered in part by the Federal Reserve’s sharp increases in interest rates over the past year, doesn’t inspire confidence that it’s time to go all in with risk-ON.

The first question: Is Silicon Valley Bank’s implosion a harbinger of things to come? No one knows, but history suggests that where there’s one bank failure there’s probably more. Indeed, Silvergate Capital, a holding company for a bank that focused on the crypto economy, announced last week that it was voluntarily shutting down its banking operations.

That’s two banking victims in one week. Is a third waiting in the wings? Financial markets appear to be pricing in higher odds for rougher waters ahead. Our 16-fund global portfolio benchmark retreated last week, falling to its 200-day moving average. It’s premature to assume that the recent rebound in risk assets has run out of road, but the next week or two could be decisive for deciding if the rally of late was noise in an ongoing bear market. See this summary for design details on the strategy benchmarks listed below.

In keeping with a fresh run of anxiety over things that could go wrong, the crowd’s appetite for safe havens perked up sharply. The change in sentiment lifted U.S. Treasuries last week, elevating American government bonds to the top performer for the G.B16 funds. For details on how the metrics in the tables above and below are calculated, see this summary.

The rise of Treasuries (IEF) to the lead position for performance marks a respite in what still appears to be a long-running slide. But in the wake of SVB, there’s growing speculation that the Fed will slow, or perhaps even pause, its rate hikes. If correct, the change cuts the headwind considerably bonds.

The logic for rethinking the Fed’s hawkish policy of late: whatever the merits of tightening policy to tame still-elevated inflation, the case for squeezing rates fades when there’s heightened risk of a banking crisis. To be clear, SVB alone doesn’t mark a banking crisis, at least not yet. But sentiment on such matters is a fragile thing. Banks, after all, are at the hear of the financial system and even modest deterioration in expectations in this corner can bring big consequences.

To be sure, some (most?) of SVB’s troubles can be laid at the bank’s door and so it’s debatable if there’s systemic risk lurking. But it’s not lost on observers that a hefty chunk of SVB’s portfolio was in Treasuries in a bid to keep the bank’s risk profile modest. The mistake, it appears, was not adjusting the maturities down as the Fed’s well-telegraphed rate-hiking intentions unfolded over the past year.

The larger point is that if “safe” bank holdings are unusually vulnerable following a rapid rise in interest rates, SVB is probably not the last bank to suffer blowback. That is unless the risk-management practices of banks overall are stellar this time.

Anything’s possible, but much depends on how the SVB collapse is handled in the days ahead. “The big question is whether the FDIC and Fed make the uninsured depositors whole—or at least close to whole,” says Bob Elliott, co-founder and chief investment officer of the asset manager Unlimited. “If the resolution of SVB Financial isn’t handled well, there’s a systemic risk that uninsured depositors will flee small banks.”

A potential problem is today’s news from Treasury Secretary Janet Yellen, who says that the government isn’t going to bail out depositors with accounts above $250,000 — the limit for Federal Deposit Insurance Corporation insurance. “We’re not going to do that again,” she advises. “But we are concerned about depositors, and we’re focused on trying to meet their needs.”

In the interests of moral hazard, that’s a good call. But from a practical perspective for the immediate future it may be a dicey move. As The Wall Street Journal notes: “The vast majority of the bank’s deposits—$157 billion at the end of 2022—were held in just 37,000 accounts that were over the FDIC’s $250,000 deposit-insurance cap.”

This could all be a small bump on the road to recovery. But with many other risk factors swirling, I’m still not inclined to be early in betting that it’s smooth sailing from here on out. ■