Bank woes whipsaw markets

Our Top Market Takeaways for March 17, 2023

Market update: Everything, everywhere, all at once

All businesses go through times of struggle. When it’s banks, it feels a whole lot worse.

The near-simultaneous collapse of Silicon Valley Bank, Silvergate and Signature Bank last week challenges confidence in the banking system. The swift and coordinated move on Sunday night by the Federal Deposit Insurance Corporation (FDIC), Federal Reserve and Treasury to reassure bank depositors was a powerful effort to instill calm. Nonetheless, investors didn’t find much reprieve until the Swiss National Bank and a consortium of U.S. banks stepped in to support Credit Suisse and First Republic (respectively) later in the week.

The swings in markets have been eye-watering: Each day this week has seen 2-year Treasury yields whipsaw more than 20 basis points in either direction, and bond volatility is the highest it’s ever been. Banks saw their worst day since March 2020 on Monday, while tech is having its best week since November.

Somehow, through everything, everywhere, all at once, the S&P 500 is heading into Friday +2.6% higher on the week.

It's unlikely this all will be resolved this week, or even this month. We wouldn’t be surprised to see more aftershocks. For now, we focus on what we know.

Yesterday marked one year since the Fed’s first rate hike, and since then, it’s increased its policy rate by 450 basis points — the most aggressive tightening cycle we’ve seen in decades. The banking turmoil seems like the latest symptom of this historic policy tightening.

We expected higher rates to have consequences and to tilt us into a recession this year. Rate hikes are meant to slow growth and inflation, and they leave damage along the way. For months, different parts of the economy have corrected in the face of these challenges (housing, manufacturing, and tech have all gone through their own reckonings over the last year), and now, the banking sector is the latest to stumble.

Granted we didn’t expect three regional banks to fail, and it seems the breakdown from higher rates is happening faster than we expected.

Some good news: It’s clear that policymakers are taking the risks seriously.

The contagion, wealth destruction and job loss experienced during the Global Financial Crisis (GFC) are etched into memory. We have confidence that policymakers developed a powerful playbook 15 years ago and are deploying it more rapidly this time around. The quick and sweeping moves from U.S. and Swiss authorities to support banks over the last few days demonstrate this commitment.

What’s more, the banking sector as a whole is in a different place today. The largest and systematically important banks are more regulated, tend to have diversified deposits, maintain fortress balance sheets, and as a result, are much better capitalized now. That’s not to say that there won’t be further stress, but that does make comparisons to 2008 an incomplete analogy.

As for what’s next, focus is firmly on watching how the Federal Reserve navigates these new stresses at its policy meeting next week.

Central bankers are now tasked with balancing both the fight against inflation and the need for financial stability. A properly functioning banking system is needed to transmit its own policy.

Before this week’s turmoil, it seemed like the Fed might need to keep pressing on the brake. It was only a week ago that Fed Chair Jerome Powell suggested the pace of rate hikes could accelerate to beat down sticky inflation.

But now, this latest shock means the cost of credit is higher and lending standards are tighter, making the decision to borrow, invest and spend more complicated. These dynamics ought to slow growth and inflation, and potentially accelerate the path to recession. As a result, we’re likely now in the final stretch of the Fed’s rate hike process. Looking ahead to its policy meeting next week, markets are split between whether we’ll see a final 25 basis points hike, or none at all.

March madness, indeed.  

Investment considerations: Steady hands prevail

Investors will continue to question the path forward, with more market swings ahead — but in the meantime, we believe the best course of action is to stay balanced, focus on the facts and be prudent.

To us, that means a few things:

1) Not taking big swings:

When it comes to times like these, steady hands prevail — and that means not overreaching for risk. That’s why we’re more closely tracking our benchmark in the core portfolios we manage, and focusing on high quality investments rather than speculating.

2) Getting defensive, especially with bonds:

The quick collapse in yields over the last week demonstrates why bonds are an essential part of a diversified portfolio. While markets may still be searching for calm, we expect rates to finish the year even lower as recession takes hold, or future stresses reveal themselves. That means bonds can offer essential protection.

The GFC, for instance, was no exception: A portfolio invested 100% in global stocks at the peak of the market before the crash would have seen steep losses of about 60%. Meanwhile, a portfolio invested in 40% global stocks and 60% global bonds would have suffered losses half as great — and only taken half the time to recover.

3) Resisting the temptation to hit “sell.”

Market timing can be a dangerous habit, and herd-following behavior during downturns or bubbles can lead to losses. History shows that the best days and the worst days for the market tend to cluster together: Over the last 20 years, seven of the 10 best days occurred within just about two weeks of the 10 worst days.

Missing those best days can have dramatic consequences. For instance, over that same 20 year period, the S&P 500 saw a 10% annual return. But if an investor missed just the 10 best days, that return would have been nearly cut in half.

Navigating these times can be challenging, but steady hands prevail. Your J.P. Morgan team is here to discuss what it all means for your portfolio.