Markets are known to act irrationally.
But these days, they’re looking unhinged.
Banks are still dominating headlines, yet stocks and crypto have remained remarkably strong in the face of what some are calling a crisis. If you thought Silicon Valley Bank’s meltdown was the beginning of something bigger, you’ve probably found yourself on the wrong side of trades.
According to the latest hot takes, the situation is black and white, bullish or bearish. People either see recent bank failures as the start of a financial system breakdown, or they shrug them off as a side effect of higher rates.
But it’s not quite that simple.
Investing — like anything in life — is rarely black and white. And in this particular scenario, the reality seems to be more gray than most think.
Don’t call it a crisis
Let’s catch up on what’s happened over the past two weeks.
Three banks closed, the Fed swooped in with an emergency bank funding facility, a bunch of big banks donated deposits to a smaller bank, and Switzerland’s biggest bank bought its second-biggest bank. It’s been a lot to process, and it’s brought back painful memories of the 2008 financial crisis.
Still, the S&P 500 has rallied 2% since the day SVB was closed, and Bitcoin has soared more than 40%. It’s hard to say we’re in any type of crisis with prices acting like that, right?
The Fed agreed. On Wednesday, Fed officials unanimously chose to implement a small rate hike and signaled they’re still more concerned about high inflation than they are banks’ funding issues. What’s more, they barely changed their economic and rate projections, and officials only hinted at the fact that they may have to stop hiking rates soon if things get worse.
So far, the consensus seems clear: Move along, there’s nothing to see here.
But is it really that cut-and-dry? Maybe not.
While prices are higher than they were on March 10, this type of rally doesn’t exactly inspire confidence.
Bank fears are still front and center. We saw this on full display Wednesday, when the S&P 500 fell nearly 2% in the final hours of trading after Treasury secretary Janet Yellen said the government isn’t considering blanket insurance for all bank deposits.
And while this may not look like an economic crisis, we could still see economic repercussions. Lending standards are tightening at an unusually fast pace, which could make it harder for consumers and businesses to borrow money. Banking issues could accelerate any weakness prevalent in the economy, even if it’s hard to quantify how severe the consequences could be.
The Fed may be compartmentalizing. Sure, the Fed put on a brave face and hiked rates Wednesday, but there were some subtle changes in their statement that could give them the flexibility to change course. The Fed switched its mention of “ongoing rate increases” in prior meetings to “policy firming” this week, then added that the extent of banking woes is still uncertain. Inflation may be the highest priority, but banks are still on the radar.
Not all rallies are created equal. Over the past two weeks, tech has led stocks higher, yet defensive sectors like utilities and consumer staples haven’t been far behind. Cyclical stocks, or those most sensitive to the economy’s ups and downs, have largely trailed over the past two weeks. To me, this looks like a market preparing for lower rates and slower growth.
Defense looks different these days. We’re also learning that defense looks a little different than it has in the past. Tech has rallied over the past two weeks, but the biggest tech companies — the ones with stronger balance sheets and competitive advantages — have pulled the sector higher. It’s different from the small, speculative-led rally we saw earlier this year.
Tech investors are playing defense this time around, not offense. You could say the same for crypto investors and Bitcoin, too. Bitcoin is a barometer for risk appetite, but it’s also seen within crypto as a safe haven.
Panic can be misinterpreted as hope. When we get blindsided by something, we tend to panic. It’s human nature. But in the past, market panic has manifested itself in unusual ways. People frantically follow the herd in search of answers, leading to large up and down movements in prices.
Take 2008, for example. That year, the S&P 500 rose 1% or more about once every four days, yet it was still one of the worst years in history for news and portfolio returns.
A complicated reality
Banking issues could accelerate the case for a recession, but they could also bolster the case for Fed cuts and lower rates. This is what’s causing so much dissonance between how investors feel and what they’re actually doing. Markets may be rallying for the wrong reasons, so try not to get hung up in the hot takes or daily price action.
And remember that your focus on quality is more important than ever. Know how your companies make money and what their balance sheet risks are.
*Data sourced through Bloomberg. Can be made available upon request.