The Perfect Financial Storm: Unraveling the Inflation linked 'Bank Failure'​ Conundrum

Market Outlook

From Stropro's Investment Team

Key Takeaways:

• The banking crisis threatens the Fed's continuing inflation fight.
• Regulatory crackdowns may lead to suppressed short-term growth, but create long-term investment opportunities in more resilient, well-regulated banks.
• In the face of adversity, it's crucial to explore alternative opportunities and keep a keen eye on megatrends, mispriced securities, and distressed assets that may offer upside returns for those who approach the market strategically.

• The banking crisis threatens the Fed's continuing inflation fight.
• Regulatory crackdowns may lead to suppressed short-term growth, but create long-term investment opportunities in more resilient, well-regulated banks.
• In the face of adversity, it's crucial to explore alternative opportunities and keep a keen eye on megatrends, mispriced securities, and distressed assets that may offer upside returns for those who approach the market strategically.

• The banking crisis threatens the Fed's continuing inflation fight.
• Regulatory crackdowns may lead to suppressed short-term growth, but create long-term investment opportunities in more resilient, well-regulated banks.
• In the face of adversity, it's crucial to explore alternative opportunities and keep a keen eye on megatrends, mispriced securities, and distressed assets that may offer upside returns for those who approach the market strategically.

The current financial landscape presents a unique blend of challenges that even the most seasoned investors are grappling with. In this month's edition of our Beyond the Stock Market, we dissect the intertwined issues of high inflation, rising interest rates and recent bank failures, providing our take on the situation to help you conquer the storm.

Riding the Inflation Rollercoaster: The banking crisis threatens the Fed's continuing inflation fight.

Inflation has become a ubiquitous buzzword, with the U.S. consumer price index at 6% YoY in February. Supply chain disruptions, soaring energy prices, and labour market imbalances point towards a more persistent inflationary environment. 

The rapid increase in interest rates has led to the failure of three U.S. banks - Silicon Valley Bank, Silvergate, and Signature Bank and of course the end of an era for 166 year old Swiss bank Credit Suisse, which was purchased by UBS for ~$3.2b.

This puts the Federal Reserve in a difficult position, as its strongest tool, the benchmark interest rate, is both the cause of the financial emergency and the primary solution for high prices. Pausing on rate increases could undermine the Federal Reserve's continuing fight against inflation, while continuing to hike rates risks further stress on regional banks’ balance sheets and the economy in general.

After a year of downsizing its assets, the Fed expanded its balance sheet by nearly $300 billion last week (refer to chart below). Yesterday, the FOMC boosted the target range for the federal funds rate by 0.25pp to 4.75-5.00%. The post-meeting statement acknowledged that the "banking system is sound and resilient," but the recent banking strain is expected to "weigh on economic activity, hiring, and inflation." The FOMC eliminated the reference to "ongoing" hikes in the post-meeting statement, and instead noted that "additional policy firming may be appropriate." A potential shift could present a significant dilemma, as their battle against inflation remains unresolved. Will the banking crisis compel the Fed to halt interest rate hikes?

Silicon Valley Bank: The Canary In The Coal Mine?

The collapse of Silicon Valley Bank (SVB) and the subsequent bailout of deposit holders has exposed the vulnerability of the banking sector. Venture capital, start-ups and crypto focused banks, once seen as pillars of innovation, are now being scrutinised for their risky practices.

This event serves as a warning: never underestimate the power of fundamentals. Below is an insightful chart on SVB, emphasising the importance for depositors, investors, and regulators to closely monitor the financial health of mid-tier banks.

Risk-adjusted metrics like these unveil the probability of bank failures, regardless of their size. A thorough evaluation requires prioritising each bank's financial stability and risk management practices. In a constantly evolving financial landscape, actively analysing bank fundamentals is of paramount importance – passive investing simply isn't enough.

The Regulatory Pendulum: Swinging Towards Stricter Oversight

The fallout from Silicon Valley Bank's failure has ignited a push for increased regulation in the banking sector. Small and medium-sized banks play an important role in the U.S. economy. Banks with less than $250bn in assets account for roughly 50% of U.S. commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending. Investors should anticipate a potential regulatory crackdown, which could lead to tighter lending practices and suppressed growth in the short term. 

Pershing Square Capital Management’s Bill Ackman said, stricter oversight may also create “very attractive asymmetry” for long-term investment opportunities in more resilient, well-regulated banks that rise above the fray. Regional bank stocks are an “incredible bargain”, he said in a tweet, adding that a decline in rates made the sector an even better investment.

When The Going Gets Tough, The Tough Get Creative

In the face of adversity, it's crucial to break free from conventional investment wisdom and explore alternative opportunities. 

The current financial storm may be unsettling, but it also unveils unique opportunities to capitalise on volatility and market inefficiencies. Keep a keen eye on megatrends, mispriced securities, distressed assets as they may offer significant returns for those who approach the market strategically.

Our investment team remains dedicated to arranging investment strategies that we believe will benefit our clients and guide you through these tumultuous times.

• 22-03-23 - AFR - Commercial Property Defaults on the rise
• 16-03-23 - AMP - Oliver's insights - Australian v global shares
• 07-03-23 - Reuters - Global supply chains have 'returned to normal,' according to NY Fed
• 03-03-23 - AFR - If you can’t earn 9pc, you’re better off in cash 
• 01-03-23 - AFR - Cash pays more than 60/40 portfolios for first time since 2001 

Thank you for taking the time to read this update and we appreciate any feedback that you might have. Please reach out to the team at any time.

If you have any questions contact us at team@stropro.com.

Warm regards,

Stropro Team

This information is for educational purposes and is not a substitute for professional and tailored financial advice. This information expresses the views of the author(s) at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views. This information uses information from sources the author considers to be reliable but does not represent that such information is accurate or complete, or that it should be relied upon.  Past performance is not a reliable indicator of future performance. Investments may rise and fall in value and returns cannot be guaranteed. Stropro makes no representations or warranties, express or implied, as to the accuracy or completeness of the information it provides.  Stropro is a Corporate Authorised Representative (CAR No. 1277236) of Lanterne Fund Services Pty Ltd (AFSL No. 238198).