Things you need to know –
– Is it starting to crack?
– Is the FED about to break the system?
– SIVB under pressure – taking the whole sector down with it.
– Strap in…Contagion anyone?
– Try the Chicken Fricassee
Who is Silicon Valley Bank? And why did it collapse yesterday? Why did they – SIVB – announce that they needed to raise $2.25 billion in ‘fresh capital’ in order to survive….sending shivers thru the industry and then the markets…..Why was SIVB down more than 60% in one session?……Taking the whole banking industry lower? The KBW Bank Index – BKX lost 7%, and the four biggest US banks lost $52 billion dollars during that same time….JPM -5.5% or $22 billion, BAC – 6.2% or $16 Billion, WFC – 6% or 10 billion and C -4% or $4 billion… and a host of smaller regional banks followed suit…..PNC, WAL, TFC, SBNY, CMA, RF, MTB, FITB, HBAN, NTRS, STT, USB, FRC, ZIONS , COF So, tell me – what happened?
Well – SIVB is the ‘Bank of the Stars’ – those stars being the whole tech industry…..startups, venture capital funds and the very wealthy C – suite at those firms……. The bank has been quietly losing deposits…….since the FED started raising rates one year ago (and you ask – how come no one knew this? Or more importantly – Who did KNOW this? ) ……..The ‘battered tech industry’ – all ‘members of the bank’ – started depositing LESS cash at the bank and then started withdrawing MORE cash FROM the bank……as the industry suffered one of its worst years in recent history…….and then more recently venture capital guys told these same startups to ‘pull their money out of the bank’ citing liquidity concerns………
Gary Tan – President of Y Combinator (a startup incubator) posted this message to his founders
“We have no specific knowledge of what’s happening at SVB, but anytime you HEAR problems of solvency in any bank, and it can be deemed credible, you should take it seriously and prioritize the interests of your startup by not exposing yourself to more than $250k of exposure there. As always, your startup dies when you run out of money for whatever reason.” Ouch!
SEE – Banks (all of them) own a lot of bonds….. Rising interest rates create an issue for these bonds……something the FED and economists and analysts are very well aware of…..especially if there is suddenly a ‘run on the bank’…….You see, rising interest rates cause the value of the existing bonds with lower payout rates (think 1% and 2% and even 3%) to fall in value because new bonds are being issued with payout rates of 4% even 5%.… Now, under ‘normal circumstances’ this usually isn’t a problem because the banks just hold them until they mature UNLESS they can’t because customers withdraw cash…..and we’re not talking about thousands of dollars, we’re talking about billions of dollars……….Remember – we are not in ‘normal circumstances’……rates have risen significantly…..(the amazing thing is – we knew this…rising rates just ‘didn’t happen’)…..We’ve seen the pressure on the economy and on the tech industry – just look at the performance last year – we’ve been discussing this for months….
So, when they are quietly (and this is a key theme) FORCED to sell these lower payout bonds to cover a ‘run on the bank’ – (think deposit withdrawals) this is what .happens…. SIVB has been (quietly) unloading these bonds for a while…. – they have been racking up these losses with every sale. Then late Wednesday (after the close) SIVB announced that they would book a $1.8 billion ‘after tax loss sales’ on investments (think these bonds) and that they were seeking to raise $2.25 billion in ‘fresh capital in order to survive….and that caused investors to dump the shares in that company, sending it down the drain, while also sending shivers thru the industry and then the markets…..Why? Because investors were not aware of the size of the losses and the need to raise new capital…..
So for simplicity – bonds are issued at par value ($100) – but will trade up or down from there depending on the payout interest rate…as rates rise – bonds lose value – again which only concerns you IF you have to sell the bond….If you don’t then you just hold it to maturity and get all of your money back…. Think about your house – it fluctuates in value depending on what interest rates are doing, what the economy is doing, etc.…But if the value of your house declines – it just a ‘paper loss’ it’s not an issue UNLESS you have to sell the house and realize the loss – if you don’t sell it then you never realize a loss….so there is NO issue.
Now – in this case – the SIVB had to sell some of the bond portfolio and realize the loss……Remember – the lower rate bonds lose value faster as rates rise….So, if you have to sell the already weakened bond – you can’t expect to get a premium, can you? NO, you don’t….and when a lot of banks are trying to sell these bonds – what happens???? Prices collapse as the buyers smell blood…..and back away…leaving a void in demand – causing prices to fall…..and fall quick….. So, if you were willing to pay $92 for the bond on Wednesday and then saw a surge in supply of these lower payout bonds on Thursday – you aren’t paying $92 anymore – maybe you’ll throw a low ball bid of $88 into the market to see what happens….and BOOM – you get hit…..which only means there is a lot of supply and more pressure to come….and so prices continue to fall…..It’s the same thing that happens to stocks – and we saw that yesterday – it’s the same thing to happen to houses, it’s the same thing that happens to anything when supply suddenly surges and sellers WANT out….Desperation causes massive dislocations….in the end – its all about Econ 101 – Supply and Demand…..this is a recurring theme in the financial markets and the global economy….this is NOT a new concept. In this case – when sellers panic – buyers benefit from the chaos…because the buyer is setting the price…. the seller makes a choice to sell or not….. Again – this just didn’t happen in one day – SIVB has been unloading these bonds for a while…. they have been racking up these losses with every sale…..but until they had to announce it, the market didn’t know it…..Capisce?
And like I said – it sent shivers thru the system….and stocks got whacked – because reality is setting in…..the FED is going to break the system….to fix it…..….the Dow falling 535 pts or 1.6%, the S&P down 75 pts or 1.8%, the Nasdaq lost 238 pts or 2%, the Russell gave back 53 pts or 2.8% and the Transports lost 300 pts or 2%.
Under the circumstances – I am surprised it wasn’t worse – because banking issues can create real chaos….Financials – XLF -4%, Communications – XLC – 2.2%, Consumer Discretionary XLY – 2.4%, Basic Materials – XLB -2.5%, Real Estate – XLRE – 2.3%….Semi’s – SOXX -2%, Disruptive Tech – ARKK -4%, and the list goes on…every sector under pressure as buyer stepped back….again – buyers didn’t go away – they just decided not to pay the prices they were paying on Wednesday…… Now the contra trades – as expected did well. PSQ, SH and DOG up 1.8%, 2% and 1.6% respectively… BUT The VIXY – which is the FEAR index was by far the winner….it surged higher…rising by 10%! Get it? It’s the FEAR index…yesterday there was FEAR….As FEAR rises so goes the VIXY….as FEAR subsides so goes the VIXY……
And that was the story…..nothing more, nothing less…..but it is all tied to what is going on at the FED and what is happening with monetary policy. Period. Now today it is all about the NFP and we have beaten this death…by now you know the deal….a stronger report will only embolden the fed to do more, causing rates to rise more, causing lower rate bonds to decline more….and again IF a bank needs to sell them – and realize the loss – then expect to see more headlines like yesterday….Now – the ones you have to really worry about are the small to midsize banks….I for one, am not worried about JPM or BAC….etc.…These are not SIVB…..Capisce?…But as long as there is this fear out there….we could see prices fall further….but for me – that chaos – in high quality names is long term opportunity…. Don’t forget that…. That is the KEY.
The coming eco data – NFP, CPI and PPI are top of mind…and this week – JJ has made it very clear that rates will not only rise, but might rise at a faster pace….FED Fund futures now pricing in a nearly 80% chance of a 50 bps hike on March 22nd….. Recall – on Monday – it was 30%.
US futures are down……. Dow down 150, the S&P’s down 13, the Nasdaq down 10 and the Russell down 10 ….NOT surprising after the performance yesterday….Investors now await the NFP report…..– So tread lightly as the market reprices….because it will reprice. And all that means is there will be new opportunities.
European markets are all lower this morning…. down about 1.8% across the board….as nervousness builds….
The S&P ended the day at 3918 – down 74 pts…..and now down thru all 3 trendlines….leaving it below the long term trendline at 3940…..Remember – earlier in the week – I said this was very possible and that we should find some support….….well, not only did it happen, we didn’t find support either – Partly due to the bank issue, partly due to Joey’s budget proposal (see below), partly due JJ’s latest testimony and partly due to deteriorating economic data….…..and partly due to rising FEAR.
If you haven’t heard – JOEY introduced $19 trillion in new taxes over 10 yrs. and is ‘offering’ to double the tax on capital gains…. from 20% to 40%…. and that’s just the beginning….and that is not a positive for stocks and for investors….in ANY asset class…. In addition the budget includes $10 trillion in rising interest payments due to FED action…..Again – why is this a surprise? Did you think interest payment were going to decline as rates rose?
Prepare yourself for more volatility……Prepare yourself for higher taxes and prepare yourself for a fight on Capitol Hill over the debt ceiling and the Democrats latest tax and spend proposals….Also expect to hear more about a ‘contagion’ situation in the banking industry after yesterday’s debacle. And as rates continue to rise – expect to hear more about consumers unable to pay bills….recall that all the big banks announced massive increases in loan loss reserves this quarter….as they warned us about the coming storm….. In the end – none of this should surprise anyone…..allocate capital accordingly…..
Take good care.
Chief Market Strategist
kpolcari@slatestone.com
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Chicken Fricassee w/Onions, Mushrooms and Cognac
Feels heavy out there…
– Fricassee is a catch all phrase used to describe the process of a stovetop – stew type of meal. It’s also used sometimes to describe a chaotic situation….like yesterday’s action in the banks…it was a real fricassee…..
You will need: 3 large white Spanish onions, fresh mushrooms – sliced thin, olive oil, butter s&p, 6/8 chicken pieces – (I like thighs – skin on), flour, chicken stock, cognac, and Italian parsley….
Now this dish is easy to prepare – it is the cooking part takes the time… Begin by slicing the onion very thin…. now add some olive oil to a heavy bottom pot that will eventually hold all the chicken. Cook the onions – covered – over a very low heat…this causes the onions to become creamy and very tasty. You should allow for 45 mins to an hour for this. Season with s&p – turning occasionally – remembering to always keep covered. When ready – uncover and turn up the heat so that the onions take a nutty brown coloring – stir so that they do not burn. Once done – remove the onions and set aside.
Next take the sliced mushrooms and add to the pot – again over med low heat – cook the mushrooms for about 15 mins…. season with s&p. Remove.
While this is happening – you have washed the chicken and patted dry with a paper towel. Dredge the chicken in seasoned flour (s&p). In the same pot – add the butter – (3/4 stick? Maybe a whole stick….) depending on how much you’re making…. and brown the chicken – do not overcrowd. Cook until the chicken forms a bit of a crust and then turn and continue to cook on the other side. When done add the onions and mushrooms back to the heavy pot. Turn the heat to med hi…. Turn the chicken to make sure it’s all well mixed. Now add about 2 tbsp. of cognac and 1 cup chicken stock – reduce heat to simmer- season with s&p and cover tightly. Cook for about 45 mins or when the meat feels tender the whole way thru.
Serve this with a nice big salad and roasted fingerling potatoes.
Buon Appetito.
