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Falling Up The Stairs

Markets whipsawed in March as both the S&P 500 and MSCI World Indices reversed an initial 3% drop to end the month positive, up 1.7%. The TSX lagged, as its combined 39% weight in Financials (-7.7%) and Energy (-6.2%) dragged the index lower by 1.6%. This divergence in performance between the Canadian benchmark and its counterparts was notable especially given its outperformance in 2022, when it limited its loss to 9%, whereas the S&P 500 collapsed almost 20%. The month of March also extended the rebound in long-term US bonds (as measured by iShares 20+ Year Treasury Bond ETF), which gained approximately 7.5% in the first quarter after falling 31% in 2022. In contrast, commodities, which benefited from the worst bond market in more than a century in 2022, decreased 4.3% year-to-date, as measured by the CRB Index. Elsewhere, gold continued its stalwart performance, up 9% in March and once again probing the US$ 2,000 level that has represented resistance since 2020.

While there is never one reason to explain any move in the capital markets, positioning certainly has something to do with it. According to the CFTC Commitment of Traders report, speculators have continued to maintain a short bias in equities. Nasdaq has been the principal short target – ironically, the index has been the year-to-date winner among equities. Meanwhile, bond market speculators were maximum short across the curve, until the first week of March. Finally, weakness in oil prices since June 2022 urged outsized short positions in WTI Crude Oil. Unsurprisingly, future contracts rebounded 14% since its low point on 20-Mar-23.

The strong S&P 500 performance masks the underlying banking stress that started early in the month. On 8-Mar-23, Silvergate Capital, a cryptocurrency-focused bank, kicked things off by announcing it would cease operations and liquidate its assets. While this was no surprise considering the questionable nature of their operations, the panic started the same day as Silicon Valley Bank (SVB) announced they would need to raise US$2 Billion to help offset a US$1.8 Billion loss on the sale of their Treasury portfolio. The forced sales were triggered by nervous depositors demanding cash amid worries about the safety of deposits above the FDIC-insured $250,000 threshold.

The fractional reserve banking system allows bank to keep only a portion of deposits on hand to fund withdrawal requests. Therefore, any shortfall must be met through asset sales. In SBV’s case, uninsured deposits were highly concentrated in Bay Area tech startups and they took unnecessary risks with these deposits by loading up on long-term bonds. Accordingly, the bank run compelled them to sell depressed assets and to ultimately shut their doors on 10-Mar-23. The demise of SBV, which had $212 billion of assets, was the largest bank failure since the global financial crisis of 2007-09. The third bank failure of the week occurred when Signature Bank was shut down by regulators on 12-Mar-23. The FDIC, along with the Fed and Treasury Department, invoked a “systemic risk exception” to back uninsured depositors and ensure trust in the system whish so far has eased domestic anxieties. However, as if not to be outdone, on 19-Mar-23, Credit Suisse was forced to sell itself to rival UBS for approximately US$3 Billion amid worries that the 166-year-old bank would inevitably disintegrate. While the S&P 500 quickly resumed its upward trajectory, U.S. Regional Banks, as measured by KRE was down 29% for the month. The S&P 500’s resilience in the face of the largest banking crisis since 2008 is impressive. However, unnecessarily tight lending activity in response to the turmoil that compounds into reduced hiring, spending and investing would intensify the economic contraction. In the event of a downward spiral such as this, more than the Regional Banks would learn a lesson in gravity.

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