The public remains rattled by the rapid collapse of SVB Financial (aka Silicon Valley Bank). SVB has exposed the operational challenges (deposits vs investments) for banks in a world where central banks have raised rates sharply. And equity and bondholders are wary given that FDIC/Fed actions wiped out stakeholders. Worsening this, several rating agencies have downgraded regional banks, moving many to below investment grade and thus raising these banks’ cost of funding.

While the collapse of SVB has triggered logical concerns of contagion, too many investors are reflexively overlaying 2008 GFC. It is the most recent financial crisis and the freshest for many. Perhaps the liquidity actions taken by Credit Suisse will calm markets, but if not, we expect communication from the Fed. Much of the problems for the banks stem from the aggressive Fed hikes which are hammering the banking industry’s securities portfolios while deposits are drained from dwindling savings, the move to USTs, and distrust of banks.

The Fed hiking aggressively further is delivering even greater pain to the banks. Fed hikes are directly driving losses for banks which was $620b at end of 2022, and the Powell testimony last week likely pushed this to nearly $900b (as 2Y and 10Y yields surged). In other words, the Fed’s monetary policy is finally “biting” (they looked for lags) and thus, the Fed can take its foot off the gas.

For the equity markets, there are signs of lingering carnage from the SIVB collapse, and these “smoking ruins” are why we believe the Fed will move cautiously into the March FOMC meeting next week. While not “explicit” in its dual mandate, the Federal Reserve Act established the Fed to “provide the nation with a safer, more flexible and more stable monetary and financial system” (thanks MH of SF for this). Bond volatility (ICE MOVE index) has surged to its highest level since 2009 and is amplifying stresses across credit and rates markets.

Our Head of Technical Strategy, Mark Newton, believes equity markets are bottoming near-term. but the next five days are critical to whether this view holds.

• In this timeframe, we get more Feb inflation/economic data and March FOMC rate decisions.
• As inflation surged in 2021-2022, investors were quick to label inflation as an era with risk of inflation being sticky for years. But that analog has not held. Even looking at lagged CPI data, inflation has softened in February compared to January evidenced by the Feb jobs report, Feb CPI and PPI. So the trend remains inflation is softening.
• The SVB collapse and the associated ripple effects across the start-up community should deliver a softening of the labor market. Moreover, with financial stability more at the top of mind for many, how many employees will now seek raises? Similarly, the credit shock and higher cost of borrowing means credit growth on the margin will slow.

These are reasons we expect inflation to fall in future months and is also evidenced by Fed rate expectations and the plunge in rates. The question is, have rates fallen due to “inflation breaking” or because “economy breaking.” reasons noted above, we think this is more “inflation breaking” and thus, Fed can take its foot off the gas. Moreover, the relative resilience of stocks (relatively milder drawdown and the lower amplitude rise in VIX) also suggest to us this drop is inflation.

• SPX and QQQ likely bottomed this past Monday; Friday’s pullback looks buyable
• Gold’s breakout to new 11-month highs should continue to drive Metals outperformance
• Utilities sector looks to be peaking after strong six-week outperformance

• There has been a lot of discussion, news, speculation, and debate surrounding the recent bank chaos. The overall equity markets have remained range-bound as investors process new areas of concern, such as Credit Suisse, and the responses from governments and central banks. Based on my interactions with clients, we are concluding the week with a fair degree of apprehension, but there do not appear to be any signs of panic.
• Next week, we will hear from the Fed and Chair Powell. The Street is eager to learn how they are considering recent events and whether it will affect their ongoing fight against inflation. It would not be surprising if the Fed suggests that the recent bank issues need to be closely monitored, and flexibility will be necessary to see how things develop. I have been in the “higher for longer” camp and see little reason to change my stance since I place a low probability that the Fed will abandon their ongoing fight against inflation.
• In terms of positioning, my work continues to indicate that a barbell approach of traditional defense and secular offensive growth, with a preference for high-quality and larger-cap stocks, is still appropriate. As a reminder, I upgraded the Technology sector in February, and my key indicators are still relatively favorable for the next 6-12 months, despite the sector being overbought in the short term.
• My primary points are still pertinent and reinforce my long-standing bearish view of the equity market. I still advise caution, maintaining a higher cash position than usual, utilizing rallies as opportunities to sell, reposition, increase hedges, and initiate new short positions. My research suggests that significant risks remain, and equities may still experience downside, with the October lows being a potential target, at the very least.

• The Federal Reserve’s recent move to inject liquidity into the banking industry effectively neutralizes the impact of quantitative tightening (QT) thus far. Although some may argue that this lending program lacks the stimulus power of quantitative easing (QE), it still results in the creation of new dollars, which will enhance liquidity as banks borrow from the Fed and depositors channel their funds into securities or other banks, triggering a corresponding demand for securities to cover the new deposits.
• The PBOC has lowered the reserve requirement ratio (RRR) by 25 basis points for all banks, except those with a 5% reserve ratio, to maintain ample liquidity and support China’s economic recovery. This move is intended to boost credit growth, lower funding costs, and encourage lending by banks, which will increase global liquidity conditions. The BTC price rose along with the Shanghai Composite Index after this announcement.
• The strengthening correlation between BTC and gold, coupled with the ongoing banking crisis, suggests that some investors may be turning to Bitcoin as an alternative investment. The current 30-day correlation between Bitcoin and gold is higher than the correlation between Bitcoin and the Nasdaq 100

Core Strategy – Despite ongoing banking concerns, the risk asymmetry in 1H remains to the upside, as liquidity conditions for risk assets should remain favorable, buoyed by global liquidity increasing. Investors are increasingly turning to BTC and gold as alternative ways to store wealth during periods of inflation or increased risk, with BTC’s rising dominance potentially leading to sustained altcoin rallies down the road.