From Silicon Valley Bank to Credit Suisse
With everything that is going on, it is time to reflect on last week's market turmoil and the likelihood of another financial crisis waiting at the gates ahead of us.
Last night's collapse of Credit Suisse, formerly one of Switzerland's most prestigious banks, has not come as a surprise. The bank has been severely mismanaged for over a decade and especially in recent years become a personal piggy bank for the company's board and upper management executives’ excessive salary and bonus payments. While its Swiss private banking division has stood firm and profitable throughout the years in a separate legal entity, the global bank has been taking financial excess to extremes, in a way mostly unknown within the Swiss banking community. The bank's resources were drained by proprietary trading bets through its investment banking arm in New York and the Far East of which most went south and led to billions in losses. The bank most likely would not have been able to survive on its own either way and the shake-up of the financial system since the collapse of Silicon Valley Bank only accelerated its demise.
Looking at the global picture, it is no secret that the monetary system is under severe stress, mainly caused by failed Fed policies and irresponsible federal government incentives that have led to trillions of additional spending for political purposes. As we pointed out last year, it is a sad repetition of what we have already seen so many times in the past: International crises on a global scale, caused by the very institutions that are supposed to prevent such events of potential mass destruction. Unfortunately, the opposite is the case and all the statements of affirmation that the "system is healthy" and the "banks are safe", which we lately have been hearing from the Fed governors and the Treasury's Janet Yellen, are either deliberately false or show stunning incompetence.
It has been clear for a while that western monetary policies have kept interest rates way too low for far too long and the sudden reversal at an unprecedented pace, combined with trillions in new government debt that led to a 50-year high inflation rate, seem to have been dangerous ingredients for a perfect storm.
The Dow Jones lost 6% over the past month and the Russell 2000, composed of 2000 small-cap companies and a suitable indicator for the health of small and mid-sized businesses, the economic backbone of America, declined by almost 12%. After major indices had already lost 20 - 30% in 2022.
Having had access to cheap money for the past 15 years has led to a debt-pile in the private sector, the government, as well as with the consumer, like we have hardly ever seen before. The availability of easy money has completely distorted the potential risk factors within the system, which it seems have also been largely ignored by many corporate and private investors alike, including those who should know best: the banks themselves.
With key rates having quadrupled within less than 6 months, the financial base for many companies and consumers has deteriorated and suddenly made life a lot less affordable and the cost of doing business a lot more expensive. Exponentially fast rising debt in the public and private sector, diminished collateral to cover past and future debt obligations, increasing layoffs, as well as quickly climbing numbers in defaults and bankruptcies are the messengers of a system that is highly unsustainable.
At this stage, there are no good options left. As long as interest rates keep going up, the market is going to go down further as both the equity and bond market are being negatively affected. Furthermore, the Federal Reserve and the ECB risk pushing the economy into a severe recession by continuously ignoring reality. If the Fed should pivot later this year, which is still our general expectation (especially as 2024 is a major election year in the United States), there is a possibility that the worst could be avoided in the short-term, depending on how much harm will have been done by then. Hence, if rate hikes should come to an end by Q3 this year, with potential future QE expectations, the stock- and the bond markets will recover. However, this would also mean that inflation is likely to stay for the time being, the financial foundation of the economy will remain fragile, and the sins from the past come back to haunt us again at some later stage. Nothing would be fixed and the classic "kicking the can down the road" phenomena continues once again, as we have seen so many times before.
Generally, we advise reducing riskier equity positions by up to 50%, move the proceeds into government and supranational bonds, precious metals, as well as Swiss franc cash for the time being. Regarding the energy sector, which has taken a substantial hit due to recession fears, we refer to our recommendation from February 15th and our advice of taking up to 50% in capital gains on existing positions. However, we are not worried about the substance of industry leaders like BP, Shell, or Flex LNG as those companies' balance sheets remain solid and dividend yields attractive.
Oliver E. Hohermuth, Principal and Chief Investment Officer