The Fed is Breaking Things
Happy Spring! The flowers are blooming and the markets are up!
It's easy to get discouraged by the renewed cycle of headline bad news; but historically, by the time a recession finally hits the real economy, the capital markets have already reacted, recalibrated, and begun to recover.
"No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant." — Warren Buffett
Then there was March. The major large cap equity and bond markets finished with positive returns for the month, despite experiencing the largest banking failure since the 2008 Global Financial Crisis. The S&P 500 is up 7% through Q1, the MSCI EAFE is up 7.6%. Bonds were largely positive.
Banking 101
Banks take deposits and lend them out or invest in securities like US Treasuries. The Federal Reserve and FDIC mandate reserve requirements. FDIC insurance was created to prevent bank runs like we just saw at Silicon Valley Bank (SVB).
Catalyst #1 — Unique lending exposure and high uninsured deposits
"It's a business that can be a very good business, when run right. You just have to avoid doing things that are ungodly dumb." — Warren Buffett
SVB specialized in lending to venture capital-backed tech start-ups. SVB held 93.8% uninsured deposits vs national average of 45%.
Catalyst #2 — Unhedged US Treasury securities
"There is no such thing as a 100% sure thing when investing." — Charlie Munger
Banks make profit on the spread between rates paid to depositors and rates they lend at. SVB purchased US Treasuries at 1.8%. While credit risk-free, they are still subject to interest rate risk. As rates rose aggressively, prices plummeted, experiencing the biggest loss in 30 years.
Catalyst #3 — Competition for cash yield
"Show me the incentive, and I'll show you the outcome." — Charlie Munger
Rising rates are good for lenders and savers but bad for borrowers. Bank yields failed to keep pace with Treasury yields. Cash deposits flowed out into 5% short-term securities.
Catalyst #4 — Fear
"You only find out who is swimming naked when the tide goes out." — Warren Buffett
When depositors needed money back, Treasuries had to be sold at a loss. Peter Thiel publicly suggested moving money elsewhere. Depositors clamored to withdraw $42 billion in cash, a quarter of the bank's deposits. The bank was insolvent and turned over to the FDIC.
FDIC Backstop
"Rule number one: Never lose money. Rule number two: Never forget rule number one." — Warren Buffett
Over 90% of SVB's deposit accounts were over $250,000 — uninsured. The FDIC pledged to insure all deposits of both SVB and Signature Bank, setting a precedent.
Likely consequences:
- FDIC limits will be raised, probably to $500,000
- Higher interest on deposits — banks will have to compete
- Bank regulations will increase. Big banks get bigger.
How this affects you
As investment advisors, we are not FDIC insured. We do not take custody of your funds. Your accounts are insured by the diversified investments you hold. We hold ~5% of your account balance in cash at qualified US custodial banks, insured by SIPC at FDIC levels.
Portfolio Changes
"Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand." — Charlie Munger
Five years and 129% return later, we exited our position in Berkshire Hathaway (BRK.B). Berkshire's position in Apple Inc. (AAPL) had reached nearly 41%. As a replacement, we purchased Broadcom Inc (AVGO).
Within fixed income, we reduced overweight to short-term bonds and re-allocated to broad international bonds.
Within equities, we slightly increased large cap developed market (ex-US) exposure.
Final Word
"Find a very smart high-grade partner — preferably slightly older than you — and then listen very carefully to what he (she) says." — Warren Buffett
Be well and #knowyourworth
Amy Hubble & Jessica Jablonowski
