Contributed by: Angela Palacios, CFP®, AIF®
The year has started much stronger than it may have felt so far. Growth-style investments trounced value-style investments as tech names came back into favor. International development beat U.S. while EM equity lagged, which was contributed by a weaker U.S. dollar. Small company stocks lagged large company stocks mainly due to a heavier technology exposure for large company indexes like the S&P 500. In contrast, the smaller company indexes had a heavier weighting in financials. The Morningstar asset allocation category of funds had 50-70% stock and 30-50% bonds, so on average, a 60% stock/40% bond allocation was up about 3.9% in the first quarter of the year.
Speaking of financials, Silicon Valley Bank (SVB), a lender to some technology companies and startups, became the largest bank to fail since 2008. Signature Bank became the 3rd largest bank to fail within hours of the SVB failure.
How did they get to the point of failure? SVB was a commercial bank that specialized in servicing the venture capital community. Over the last few years, there has been much activity in venture capital fundraising, and many deposits flowed into the bank in late 2020 and 2021. SVB's balance sheet at this time went from $70 Billion to $200 Billion, while lending was only a fraction of what they did. So they had excess levels of liquidity and took most of that money to purchase treasuries. Their intention was to hold to maturity, so while they didn't have credit risk exposure, they had a lot of interest rate risk. During 2022 they experienced deposit outflows as venture capital companies were experiencing a lot of spending outflows and not as many inflows. At the same time, interest rates increased, causing unrealized losses in these bonds. As money continued to flow out of the bank, this caused a liquidity issue which forced the bank to sell treasuries at a loss to meet withdrawal demands. So ultimately, high amounts of interest rate risk and sector concentration were the main reasons for failure.
What about contagion? It's important to remember that banks do fail almost every year. Usually, they are caused by Fraud or mismanagement. But there are times when something bigger is going on that can cause multiple banks to fail. In the chart below you can see the largest amount of failures happened in the 1980s due to the farm crisis, oil prices, and the S&L crisis. The great recession was another big wave of bank failures.
In the case of the most recent failures, the government acted quickly over the weekend to create policies to back-stop banks that may need to sell treasuries to meet customer withdrawals. These policies allow banks to take cheap loans backed by those treasuries for a short term to meet depositor withdrawal demand if needed without booking losses.
Are my deposits with you covered by FDIC? We diligently review FDIC coverages for our clients. If you're unfamiliar with the Raymond James Bank Deposit program, here is a primer. One account at Raymond James through the Raymond James Bank Deposit Program (RJBDP) can provide up to $3,000,000 ($6,000,000 for joint accounts) of total FDIC coverage. Raymond James does the work behind the scenes as available cash is deposited into interest-bearing deposit accounts. RJ uses a waterfall process to ensure higher cash levels for clients than the traditional limits. With the Raymond James Bank Deposit Program, uninvested cash is deposited into interest-bearing deposit accounts at up to 20 banks, providing this increased FDIC eligibility.
Raymond James will deposit up to $245,000 ($490,000 for joint accounts of two or more) in each bank on a predetermined list. Another way to qualify for more coverage is by holding deposits in different ownership categories (account types such as an individual account, a trust account, and an IRA all qualify for their own FDIC coverage).
Is my money safe in Raymond James Bank? Questions about how Raymond James is positioned in this stressed environment? Watch this video.
Cash management is a much more active process than in the past. Short-term treasuries, Certificate of Deposits, and money market mutual funds offer attractive rates for the right investor. While these options don't carry FDIC coverage, they shouldn't be ignored. Talk to your advisor to explore what might be right for you if you're carrying large cash balances at your bank with no immediate need of utilizing the cash.
The U.S. government is close to its limit (Debt ceiling), where it can no longer borrow additional funds. Several months ago, Congress had to begin using "extraordinary measures" to fulfill some obligations, and the clock is ticking for them to be able to come to an agreement and raise the debt ceiling so that spending can continue without pause. Estimates show these measures run out as early as June. The issue is typical (see other times when the debt limit was raised in the graphic below), but a divided Congress can make the issue more contentious. The main holdup is that Republican opponents want to see spending cuts before the ceiling is raised, and spending cuts are not easy for anyone to agree upon.
Expect volatility as deadlines to meet obligations approach and the market's price is in more uncertainty. The direct impact and potentially biggest worry for investors is the risk of the U.S. government defaulting on its Treasury debt. Additional pain in the form of spending cuts would have a direct economic impact, with uncertain outcomes and hard decisions being made on where to cut the spending. There is no way to predict the future, but history as a guide would suggest a deal is reached and the ceiling is once again raised as it has been every other time the issue has come up in our lifetimes. We lean on diversification, conservative portfolio positioning, and a sound financial plan during times of uncertainty, and we're always here to answer any questions you might have on the topic.
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Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.
Any opinions are those of the Angela Palacios, CFP®, AIF® and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not a guarantee or a predictor of future results.