Interpreting current market volatility
Please note: The article does not constitute advice or any form of investment recommendation. All numbers quoted were sourced from Bloomberg data as at Thursday 16 March 2023. Past performance is never a guarantee of future performance.
The much-publicised collapse of Silicon Valley Bank (SVB) in the US has spooked financial markets in recent days, with a ripple effect being felt across the global banking sector.
It is an acute reminder of the interconnectivity of markets, the unpredictability of life and the need for investors to be diversified.
That said, this is not a repeat of the 2008 global financial crisis, and central banks have moved quickly to reassure markets.
SVB was a relatively young bank with a niche clientele. Founded in 1983, it was one of the top 20 US banks by assets1 and popular with tech start-ups. Its collapse was brought on by today’s challenging macroeconomic climate, and tough interest rate environment.
The issue flared up because SVB had invested heavily in US government bonds, but had not hedged its exposure to the bonds – in other words, it was ill-prepared and lacked a cushion if things didn’t go as planned (it’s important to remember that US government bonds remain a solid asset class for long-term investors in traditional portfolios).
Unfortunately for SVB, as US interest rates rose sharply in 2022 to curtail soaring inflation, the value of SVB’s bond holdings declined. This was further compounded by some of the bank’s tech clients withdrawing funds to ease their own liquidity challenges.
In essence, SVB was being pulled in two directions – a declining bond book, and an increase in client withdrawals. In the end, the strain and their lack of protection proved to be too much.
While there may be further ramifications in the banking sector, the chances of mass contagion are small. In the aftermath of the global financial crisis in 2008, banks were required to increase and maintain robust capital ‘buffers’ to cope with future shocks to the system. Risk management was also tightened up, in an effort to provide more defence. The sector will never be completely immune to problems, but there is more resilience than ever.
Events in Europe
The most recent strain has been felt in Europe, with the Swiss central bank announcing a series of actions intended to rebuild market confidence.
Specifically, the banking giant Credit Suisse – which recently declared ‘material weaknesses’ had been identified – has been allowed to borrow CHF50 billion from the Swiss National Bank (SNB). In addition, Credit Suisse will repurchase some of its debt in the open market.
It was an important intervention by the SNB and appears to have calmed investor nerves, for now at least. At the time of writing, the FTSE 100 was up 0.9%, clawing back some of the losses from yesterday.
The events of the past week highlight how quickly market sentiment can move, and the consequences it can have, such as bank runs becoming self-fulfilling prophecies due to herding behaviour. Heightened risk-aversion can exacerbate contagion. This is important for understanding events at the market level and is also an important lesson for investors at the individual level.
Being caught up in the headlines, being influenced by the psychology of others, and losing sight of the distinction between them and the underlying fundamentals (of the market, companies and one’s own portfolio), can have far-reaching (negative) consequences on investment decision-making.
Whilst these dynamics create risks for investors, they also provide opportunities for those who can see through the noise. As ever, the value in maintaining a long-term perspective and in staying diversified, is clear.
Given this is an extraordinary development for global investors, we’ll provide more updates when there are significant events worth commenting on.
In addition to our ad hoc thought leadership client call on Friday 17 March 2023, we’ll continue to record our Markets Weekly podcast.
The next edition of Market Perspectives – our signature investment report – is also due out in the week commencing 3 April 2023.