Return-Free Risk

Another week, another bank collapse...

(Source: Getty Images)

Joel Bowman, checking in today from Buenos Aires, Argentina...

“Until something breaks.” 

That’s been the prevailing view here at Bonner Private Research: that the Fed will keep raising rates until something goes very, very wrong. 

“Then, when the going gets tough,” Bill Bonner reaffirmed this week, “the Fed is still likely to abandon its war on inflation. Soon, it will retreat, and conduct only rear-guard harassment operations.”

Dear readers may want to know... with news of yesterday’s implosion of Silicon Valley Bank (SVB), the largest banking collapse since the 2008 financial crisis and the second biggest in US history, has something “broken” yet?

“[I]f the banking business is ultimately a confidence game,” reads an article in The New York Times (hint: it is), “the game ended quickly.”

Continued the Old Gray Lady...

The collapse may have been an unforced, self-inflicted error: The bank’s management chose to sell $21 billion of bonds at a $1.8 billion loss, in large part, it appears, because many of those bonds were yielding an average of only 1.79 percent at a time when interest rates had risen drastically and the bank was starting to look like an underperformer relative to its peers. Moody’s was considering downgrading its rating.

Which begs the obvious question: How many other banks are in a similar situation, holding bonds with puny yields which, in an environment where 6-month Treasuries pull down >5%, will readily be seen as “underperforming”? And what, ultimately, is the quality of these banks’ underlying assets, including Mortgage Backed Securities (MBS) and Commercial Mortgage Backed Securities (CBMS) in a sudden – or even slow moving – real estate downturn?

BPR’s macro man, Dan Denning, was sifting through the SVB wreckage yesterday. We’ll return to his insights below, but first a quick peek at the rest of the markets...

The Weekend Wrap

The major indices all fell for the week, with the Dow Jones Industrial Average logging its worst performance since June, 2022. The 30 blue chips slid 1.1% on Friday, taking losses for the week to 4%. The S&P 500 and Nasdaq shed 1.4% and 1.8% on Friday, pushing their weekly losses to 4.6% and 4.7%, respectively.

Year to date, the majors are a mixed bag. As of Friday’s close, the Dow is 3.7% in the red. Up 1%, the S&P 500 is still clinging to positive territory...just. The Nasdaq is up 7.2% YTD, though it’s down 6.3% over the past month. 

Of course, one bank run does not a credit crisis make. But what if this is not an isolated incident, as mainstream news outlets so glibly reassure us? What if SVB was not a singular event, but a synecdoche for something unseen, lurking beyond the horizon? This is the second weekend in a row we’ve written of bank failures, after SVB followed crypto lender, Silvergate, across the River Styx. Hmm...

Predictably, bank stocks were responsible for much of the uncertainty on Wall Street last week. JPMorgan Chase, Wells Fargo and Bank of America each fell around 6% on Thursday alone. By week’s end, the S&P Banks Select Industry Index had plunged almost 15%. 

Meanwhile, spot gold jumped 2% on Friday to trade around $1,865/oz. Central banks continue their buying spree, with Singapore’s central bank upping its reserves by a whopping 30%... in January alone. Central banks globally added 77 tons to their gold reserves in January, according to the latest data from the World Gold Council, a 192% increase from December. China and Turkey were among the world’s biggest buyers for 2022. (Another “hmm...”)

Over in cryptoworld, meanwhile, Bitcoin got clobbered last week. At one point on Friday the top digital dog even surrendered the psychological $20,000 battle line. It has since recovered some territory but was nonetheless down over 9% for the week. Bitcoin is up 22.5% for the year. 

And finally, big news on the energy/geopolitical front this week was the normalization of diplomatic ties between oil and gas giants Saudi Arabia and Iran... in a deal brokered by... China. (Ok, now we’re beginning to run out of “hmms...”) 

The trilateral agreement raises concerns regarding America’s role in the Middle East, especially as Saudi is known to be in active talks with China and considering pricing some of its oil in yuan, further undercutting US global petrodollar hegemony. 

Oil is hanging steady at ~$77 per barrel (WTI). 

Given the swans of unidentifiable color circling above (or are they vultures?), is it safe to be invested in the stock market right now? In fact, does the market present anything other than the promise of return-free risk?

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BPR investment director, Tom Dyson, had a similar question on his mind when he wrote to members this past Wednesday...

The U.S. government is the most in debt as it’s ever been, its deficit spending is out of control, and it’s about to be served with a historic rise in interest rates.

After rising for years, asset prices – including stocks, bonds, and real estate worldwide – have formed downtrends in the charts. The Fed is actively trying to pop the bubble. 

There’s war in Europe, including trench warfare. The war seems to be getting bigger and sucking in everything around it, like a twister or a black hole. 

And perhaps most importantly, FOMO (the fear of missing out) has turned into JOMO – the joy of missing out. We can now sit on the sidelines and get paid 5% interest for holding cash and watching from afar.   

So my question is – why would anyone want to own stocks or bonds or any risky investment under these circumstances?

I know it’s not exciting, but I continue to recommend subscribers assume a posture of maximum defense.

For readers just joining us, “maximum defense mode” is a strategy Tom and Dan have honed over the past year to help protect your purchasing power through the unfolding collapse we’re witnessing week to week. 

The idea here is to have a significant portion of your portfolio in cash (to protect against nominal price declines) and gold (to hedge against currency debasement). The remainder is deployed to generate income, as Tom explained...

The major stock market averages and bond markets are uninvestable, right now, in my opinion. If you’re like me, you don’t want any exposure to the major stock market averages or bonds of any duration greater than one year. The equity ideas we’re tracking [in the Bonner Private Research Official Stock Watchlist] are mostly income ideas, that is, we aren’t relying on rising prices to make money from them. We’re relying on dividends and option premiums. 

As I've said many times, our mission right now is to keep our capital, not grow our capital. When the conditions change, we’ll change, but not today.

If you want to follow along with Tom’s recommendations, including the Official BPR Stock Watchlist, consider becoming a member here...

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Meanwhile, let’s return to Dan’s postmortem of SVB and the potential dangers lurking in the system...

The real problem here–in my view–is in MBS or commercial mortgage backed securities (CMBS) that banks loaded up on when rates were low and the yields were relatively higher. What are these securities going to be worth in a housing price crash? In a recession where occupancy rates for commercial properties plunge?

The banks could try and sell some of these MBS and CMBS (if they aren’t required to hold it to maturity). But sell to whom? And if at a loss, what effect would that have on equity and investor confidence?

Most of America’s banks ARE better capitalized now than they were in 2008. But now there is concern about the quality at the core of their capital structure (MBS and Agency securities). If they really wanted to reassure depositors and prevent a bank run like what happened at SVB, the banks would raise interest rates on time and demand deposits. 

With less leverage overall in the banking system, and the Fed always looming in the background as a buyer of last resort, this doesn’t feel, to me anyway, like a Lehman Moment in 2007. Or a Bear Stearns moment. I was around for both of those. And this doesn’t feel the same. At least not yet.

But we may not need or get one single major ‘credit event’ to trigger a revaluation in stocks. It may be a grinding crisis of attrition that doesn’t accelerate but maintains a relentless path of lower highs and lower lows.

If SVB is ‘contained,’ to use another infamous word uttered by former Fed chairs, it doesn’t mean it won’t have an effect on bank stocks, bond prices, and the stock market. The bank stocks will likely sell off further until investors can be sure of what each banks’ exposure to MBS and CMBS is (this is where a lot of risk now lies in the financial system, on the unexamined balance sheets of individual firms).

If there IS further trouble with regional banks, it may increase the likelihood that the Fed purchases illiquid assets from troubled regional banks. More Quantitative Easing (QE)! And before the recession. The SVB fall out may also decrease the likelihood of a 50 bps rise at the next Fed meeting on March 21-22. 

If you get QE sooner than that–for any reason–you’d expect a lower US dollar, a higher gold price, lower bond yields/higher bond prices, and lower stock prices.

Again, if you’re not already following along with Dan and Tom’s twice-weekly updates, you’re missing a heckuva lot of valuable information. Join the Bonner Private Research team here...

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And now for Bill Bonner’s missives from the past week...

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And that will do it for today’s Weekend Wrap... 

We’ll be back tomorrow with your usual Sunday Session, including some reader mail from your fellow subscribers, who wrote in to tell us what they like about BPR and some helpful suggestions on what we might improve in the future.

We’ve also got a survey in store so you can have your say. Keep an eye out for all that, mañana.

Until then...

Cheers,

Joel Bowman