If you’ve been reading my blog posts over the past 15 months, you should know clearly that the advisors at Capstone Wealth Management Group have been observing caution and making investment adjustments to lower overall risk in client portfolios. Our “run for cover”, so-to-speak, began in late 2021 and early 2022 where we were taking profits and reducing exposure to areas of the market where risk/reward tradeoffs were unattractive to say the least. During that timeframe, the S&P 500 Index has declined by nearly 20% and bonds, on average, fell 13% simultaneously as the old “60/40 portfolio” got bludgeoned.
So, what did we did see and why did we move to lower portfolio risk?
Well, first off, I am not suggesting that we have the proverbial “crystal ball” or that we can predict the future, but we did take action when reading into the many indicators and market metrics that we watch closely were flashing red. The most glaring and prevalent issue that hit our radar was inflation. As I have mentioned in previous messages to clients, the inflation rate at the end of 2020 was around 1.4% and by the end of 2021 it had skyrocketed to nearly 5% - it was an innocuous move, right? Well, I suppose our Federal Reserve Chairman, Jay Powell, and US Treasury Secretary, Janet Yellen, both thought so as they described the 357% move as being “transitory”.
Inflation is an economy killer, and it should have been taken more seriously at the time by the Fed and the Treasury and, had they taken action, we very well could have avoided where we are today – talking ourselves off the ledge.
So, are we in a financial crisis now? Many would argue that we are indeed.
Earlier this month, Silicon Valley Bank, a tech startup-focused lender based in Santa Clara, California, collapsedoutright marking it as the second-largest bank failure in American history and sparking a global panic throughout the entire banking sector. There have been reports that the San Francisco Fed, more than a year ago, had been noticing problems at SVB – including how the bank was managing risk exposure to changes in interest rates and whether or not it could survive with the amount of capital reserves on its books. In fact, eight months prior to the bank’s failure, SVB did not have a chief risk officer overseeing its financial operations and has been criticized for employing a diversity officer during that same eight-month period. It seemed that SVB was focusing more on environmental, social, and governance (“ESG”) policies and practices rather than the management of its operations as a bank. On March 9th, SVB customers withdrew $42 billion in 10 short hours and, from there, the bank crumbled.
SVB’s failure triggered a domino effect in regional banks across the country as depositors frantically withdrew their money, fearing that the “plumbing” in the system had seized up and that contagion was imminent and, in fact, it was. Two days after SVB collapsed, a bank run on New York-based Signature Bank forced regulators to close its doors and First Republic Bank had to be bailed out by other financial institutions even though it seems still to be hanging by a thread. Overseas, Credit Suisse, which has been troubled for years, was the next victim until Swiss central bankers convinced UBS Group, AG to buy the beleaguered bank’s assets for $3 billion over the weekend.
Who’s next you may be asking, how did we get here, and is this another ’08-’09?
To figure that one out, maybe understanding a crisis would be the best way to start. The lifecycle of a crisis has six stages…Warning, Risk Assessment, Response, Management, Resolution, and Recovery. Our warning was inflation and valuations. As the COVID-19 pandemic rolled on, the printing press at the US Treasury was buzzing and stimulus checks flew from helicopters paying people to stay home and that punch bowl was filled to the top all the way through 2021 and into 2022 as government spending raged on (we even passed a bill to spend more money in an effort to fight inflation – that one was a head-shaker!). With money being flooded into our economy, demand for goods and services surged and, alongside a paralyzed supply chain, huge amounts of money chasing fewer goods and services created an inflation timebomb while markets bubbled up as the “free money” also made its way into the Nasdaq, “FAANG” stocks, Bitcoin, and of all things, shares of bank stocks like SVB.
At Capstone, we accepted the warning sincerely and began our risk-reduction tour at that time.
The next phase is risk assessment and, if you ask me, that’s where we are right now. We have banks failing and likely, more fallout to come, while no one has been able to determine what the consequences really are going to be in our economy and capital markets. In the risk assessment stage, good and bad headlines will flip through media outlets and social platforms at a rapid pace resulting in craziness in the markets. This is why you will see big rallies in stocks and extreme sell offs as well almost daily. Volatility is alive and well!
The response stage and risk assessment stage can overlap. For instance, as a response to SVB and other banks failing, the Fed has provided funding (here comes QE again!) at the “window” to help shore up balance sheets and cover losses. Additionally, the Treasury has covered all deposits with FDIC insurance including those above the $250,000 limit for individuals and deposits of corporations which are in the billions. So, we’re not completely in a “response” mode, but the Fed is acting quickly albeit for better or possibly worse. We also have an upcoming Fed meeting this week and investors are paying attention to the 2-Year Treasury Yield as it tells us what the market is expecting from the Fed in terms of rate action. Yesterday, after the market close and a rally in stocks, the 2-year was telling us that we had around a 40% chance of a 25 basis point hike and the yield was 3.70%. Overnight, rates are jumping and now sitting at 4.13% with odds of a rate hike are 74% - what is that telling us? It tells us that the market can’t decide whether it wants the Fed to support stability or continue the fight against inflation. In light of what is occurring around us, the likelihood of a raise has been falling, but if they go, this would be the ninth interest rate increase by the Fed since March of 2022 and it feels irrational and very confusing, considering their recent easing efforts in an attempt to rescue failing banks and protect depositors. Either way, investors are nervous and are now abandoning their confidence in the system – which isn’t seeing very much insider buying of bank stocks these days.
From this point forward, it will remain to be seen what management, resolution, and recovery can look like. In a financial crisis, the stakes are very high, consequences can be severe, and blame will run rampant. For now, though, investors need to pay close attention to the risk in their portfolios, take action where and when necessary to reduce risk, while closely monitoring portfolio “downside capture” if the market falls further. “Getting through” means outpacing the underlying benchmark (that is, lose less!) which can only be accomplished by recognizing how risk needs to be managed and mitigated properly.
Since the end of last year, Capstone advisors have been telling clients to brace themselves for the possibility of another down market this year. While it is impossible to determine what 2023 will ultimately bring, it is highly probable that the landscape will be challenging, and markets may have a difficult time finding their way higher. This is because inflation, even as it has been coming down, still remains stubbornly high, interest rates are miles higher from where they have been for more than a decade and remain on the rise, loan supply is tightening in a high-rate environment which can hurt banks, many companies are laying off workers, and the consumer is rolling over quickly as high interest consumer debt has been piling up. We expect that we will see unemployment move up as the Fed’s actions “break” things in our system and possibly lead us to economic recession as it appears the Fed missed the mark AGAIN, reacted impulsively, and was too late to the rescue…some analysts still believe that Powell can steer us to a “soft-landing” in the economy but are banks blowing up part of a “soft landing”? We don’t think so.
All of this being said, there are investment and risk management strategies that all investors should consider in times like these that can “bridge the gap” to better times and to recovery. It’s always important to remember that stocks go up more than they go down over long periods of time, and we are investors for decades, not months, weeks, or days. For Capstone clients reading this message, please know that your advisor’s hands are on the wheel, your best interest is served ahead of all else, and, as always, if you need to speak with us, just call. For any readers of this post that are not Capstone clients, if your portfolio hasn’t been properly adjusted to weather any storms on the horizon, call us for a no cost, no obligation investment “check-up”. We welcome your questions and are happy to help wherever we can.
You can reach us by calling (570) 587-7800 (office – direct) and 888-587-7526 (toll-free) or please go to www.capstone-wealth.com for more information!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.