Market Radar 13. March 2023


Will we soon see new highs in bonds and new lows in equities?

On Friday, we saw significant increases in the price of US Treasuries on Wall Street.
The ETF for US government bonds with maturities of one to three years (SHY) gained 0.5% on Friday. Considering that this ETF has suffered a drawdown of almost 1.5% at its peak since the beginning of February, a third of these losses were recovered on Friday alone.

In the ETF for US government bonds with maturities of 20 years or longer (TLT), we see a simultaneous price movement to the SHY ETF, which of course has a broader price range in percentage terms, as long-term traders make significantly more volatile movements than short-term ones: The TLT ETF gained almost 3.5% on Friday. Since the beginning of February, the TLT ETF has recorded a drawdown of almost 9.4% at its peak. Here, too, a third of these losses could be made up on Friday alone.

Until Friday, March 3, we observed a convergence of bonds and equities on Wall Street. If stocks lost, bonds also lost. From last Monday, bonds and equities began to form opposing daily price developments. At the beginning of the trading week, these were only visible to those stock market participants who observe bonds and shares as an asset pair on a daily basis anyway. By Friday at the latest, however, every stockbroker saw that bonds and shares were going their separate ways. On Friday, the S&P 500 (SPY) lost 1.44%. The ETF for US Treasuries with maturities of 20 years or longer (TLT) gained 3.45% on Friday.

Such a ratio of 2.39 (TLT versus SPY) is unusual and absolutely not normal at this level. This high negative correlation between bonds and equities on Friday could now serve as a launch pad: On to new highs in bonds! Down to new lows in equities!

Some private investors are likely to have been informed by the market this weekend at the latest that it could be a good idea to exchange shares for government bonds in their portfolio.
By September 2022, both assets suffered a “valley of tears” together. From early October 2022 to early March 2023, both assets recovered from their lows.

And how will equities and bonds continue to develop in the coming months?
If both move negatively correlated in the market from now on, then we could soon see new highs in bond ETFs and new lows in US equity ETFs.

A negative correlation between bonds and equities is also normal in times of “normal interest rate policy”. On days when stocks rise, bonds lose. On days when bonds rise, stocks lose. Bonds are now becoming doubly attractive: on the one hand, they could outperform US equities in the coming months. And if it happens the other way around, i.e. equities perform better than bonds, bonds at least lead to a less volatile capital curve in the portfolio – provided that the negative correlation persists and does not evaporate again.

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What do we see under the radar of the major stock indices?

Bank collapse in California

The two regional banks SVB Financial Group (SIVB) and Silvergate Capital Corporation (SI) will no longer be on our radar in the future, as both banks are being wound up.

Since I have already reported several times on the market radar since November 10, 2022 about Silvergate Capital Bank, which has been a player in the cryptocurrency business that should not be underestimated, I would like to focus on Silicon Valley Bank today. After all, until recently, this bank was one of the 20 largest regional banks in the US.

California banking regulators on Friday shut down SVB Financial Group, which we now call Silicon Valley Bank, after the bank, which had $209 billion in assets at the end of 2022, experienced a rush with customers withdrawing as much as $42 billion in a single day. This run on the funds forced the regional bank, which mainly held deposits from start-up companies, to report to the California banking regulator as insolvent.

On Saturday, Y Combinator, a go-to place for startups that helps early-stage entrepreneurs with money, advice, and contacts, released a petition to U.S. Treasury Secretary Janet Yellen and other regulators. The petition calls for bailouts of startups that had deposited funds with Silicon Valley Bank. Around 87% of all deposits were uninsured, so many start-up companies could be on the verge of collapse.

But it’s not just Silicon Valley startups that are affected. Over the weekend, it became known that startups and listed companies from Asia and Europe had also parked their money at Silicon Valley Bank. Among others, the German cooking box provider HelloFresh (WKN: A16140) is affected. The stock had lost about 20% in value in the last four trading days.

U.S. regulators are currently seeking to sell Silicon Valley Bank assets. At the same time, the global asset manager and lender for technology companies, Liquidity Group, announced on Sunday that it would offer emergency loans of around $3 billion to startup firms that can no longer access their deposits with Silicon Valley Bank. Presumably, other banks will offer similar offers next week for start-up founders who are now in distress.

A takeover of Silicon Valley Bank by a major bank is also a scenario that should be taken into account for this trading week. This would probably lead to a strong recovery movement in banks – at least for one day. For the new trading week, we should therefore face high volatility on the stock markets.

The collapse of Silicon Valley Bank is seen by experts as a direct result of the Fed’s aggressive interest-rate hike cycle. This collapse represents a narrative that, until a few days ago, was still beyond the radar of most central bankers; and for this very reason can now lead to an unexpected stress test – with the potential for a black swan event for the US banking sector and possibly beyond for the global financial system.

Well-known investors such as Kyle Bass and Bill Ackman stressed over the weekend that the government must act quickly now to prevent the collapse of Silicon Valley Bank from triggering further collapses in the banking system.

“If you go into a turnaround so aggressively after creating so much inflation, you’re going to break something,” said Kyle Bass, founder and chief investment officer of Hayman Capital Management. “And what they (the Fed) will learn is that the speed at which they raised interest rates is just as reckless as the speed at which they printed money.”

Presumably, Silicon Valley Bank management had not taken into account that deposits are declining while interest rates are rising. Normally, deposits rise as interest rates rise.

In addition, there was poor risk management on the part of Silicon Valley Bank: the bank had invested the sharp increase in deposits in long-term bonds, which are known to have lost significantly in value. As companies increasingly withdrew their deposits because they either needed the money, saw the risk or simply wanted to achieve higher interest rates on the money market, there was a liquidity bottleneck. This loss of deposits depleted cash reserves, because the now forcibly sold securities incurred losses that were not nominally on the books. These forced sales put the bank’s equity into negative territory, so the state had to take over.