Gill Capital Partners April 2023 Update
Spring is here, and with it comes change, renewed optimism, and, of course, spring cleaning. This spring has ushered in a more positive overall market environment despite plenty of negative headlines, and a sense of change is certainly afoot. There is no shortage of topics to review, as banks continue to find themselves in the headlines and nervous depositors seek safety. Additionally, there are updates on inflation, the Federal Reserve, interest rates, and a surprisingly resilient stock market. We will get into all of this and more, but first, the interesting factoid of the month:
Did you know that in England, spring cleaning is practically a national holiday and takes place for two weeks each year? Citizens are not only advised to spring clean their homes and property, but their finances, technology and state of mind.
Banking and Charles Schwab Update
The story that started with the failure of Silicon Valley Bank and saw the FDIC provide unlimited deposit guarantees has continued to evolve. Deposit outflows, combined with fears of losses in bank loan and investment portfolios, have hammered bank stocks, particularly small and regional banks, which have seen the worst of the outflows. Federal Reserve data provides hard proof that money is flowing out of small banks and into larger institutions. Over the last few weeks, small banks have lost $108 billion in deposits, while the nation’s 25 largest banks (including JPMorgan and Bank of America) grew by $120 billion. Depositors are moving money to take advantage of the $250k FDIC insurance limit and to invest in money market funds at brokerage firms that provide expanded SIPC coverage while paying significantly higher rates than most banks.
Why has Charles Schwab been in the news lately related to this situation?
It is important to understand that Charles Schwab has two distinct but connected sides to its business: brokerage and banking. Charles Schwab is the nation’s largest brokerage firm with over $7 trillion in client assets across 35 million accounts, which includes the acquisition of TD Ameritrade. It also has a banking arm, which ranks as the nation’s 10th largest bank with $370 billion in deposits as of the end of 2022. Client assets such as stock, bonds, mutual funds and other securities are held in custody at Charles Schwab and are the property of the account holder. The brokerage firm has no ownership or even access to these assets as they are required to be segregated from firm assets. In the highly unlikely event that Charles Schwab failed, your assets would remain, and you could transfer them to another brokerage institution. The concerns related to Schwab are focused on the banking side of the business, not the brokerage side. The banking side is susceptible to the same risks that any other bank is, and, as such, their stock has suffered like many of the bank stocks. However, brokerage accounts and the assets they hold are not at risk of loss in a situation where the bank may have insufficient liquidity due to depository withdrawals. In fact, the brokerage side has been a significant beneficiary of bank outflows. We have been having many conversations over the past few weeks with clients about how to maximize FDIC and SIPC protection, and it certainly warrants a conversation if you have excess cash in bank accounts.
Banking Update
The government response to the situation that led to the collapse of both Silicon Valley Bank and First Republic Bank was sufficient to avoid a cascade of bank runs and provide depositors confidence that their money will be protected and available. The government utilized a two-pronged approach. First, they guaranteed depositors’ accounts on an unlimited basis, thereby reducing customers’ fear and, hopefully, the desire to pull money from banking institutions. Secondly, the Federal Reserve approved a new lending facility where banks could borrow against their assets, including U.S. Treasuries and mortgage-backed securities, at full value, as opposed to liquidating them and taking significant mark-downs. These are high quality assets that may be currently valued at less than par due to the rapid increase in interest rates but will provide full value when held to maturity.
Our view – This is not the Federal Reserve and the Treasury’s first rodeo. Their programs stemmed the bleeding and instilled confidence in the banking system. Problem solved, right? Not so fast, sadly. While bank depositors can rest assured that the government will continue to do what it needs to maintain confidence in the banking system, there are some fundamental weaknesses in some of the smaller and regional banks. Many were created by rapidly rising interest rates and others are just a natural by-product of economic cycles. Unfortunately, both are converging on regional and small banks at the same time. Furthermore, analysts are concerned about the significant value of commercial real estate loans that are set to mature this year that might add fuel to the fire for small and regional banks. While bank stocks have dropped significantly over the past few weeks, they might not be a value play just yet. We have confidence in the banking system and believe that money is safe in banks, but we are not rushing out to buy bank stocks as it is the bank shareholders who appear to be at risk, not the depositors.
Update on inflation the Federal Reserve, and Markets
The closely watched Consumer Price Index (CPI) report for February showed a continuation in the downward trend in inflation, as the reading fell to 6% from a year ago and increased 0.40% from January. Both readings were in line with analyst forecasts.
Our view –Markets liked this number. Inflation is continuing to moderate, led by vehicle prices, which are seeing outright deflation on a year over year basis. Housing inflation continues to be stubbornly high and now comprises 60% of the monthly inflation calculation. With inflation slowly continuing its downward trajectory and turmoil in the banking system, the interest rate picture has changed dramatically. One month ago, right before the Silicon Valley Bank collapse, markets were anticipating materially higher interest rates by the end of the year. In a matter of a couple days, analysts and bond markets shifted their focus and now all bets are on lower rates. Yes, we are now talking about rates dropping sometime in 2023. The bond market is pricing in a Federal Reserve rate cut of 1.75% by the end of 2024, a monumental shift. What changed? The fear of a banking crisis. There could be one more rate increase, but we feel the Federal Reserve is likely at or near the end of their rate hike campaign. We have been taking advantage of higher rates over the past few months and locking in the highest rates we have seen in many years. Equity markets also appreciate the possibility of lower rates and ended the quarter on strong footing with tech stocks leading the charge higher. Equity markets have exhibited a lot of strength lately in the face of bad news and that is a good sign.
Enjoy the upcoming Easter weekend and get after that spring cleaning!
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.