March rounded off the first quarter as one to be remembered for the sense of crisis that markets were heading upwards but towards a cliff-edge. As March unfolded, many thought that the cliff edge had been reached. Fortunately, it appears that the drop was just a few feet down and the hill continues.
For global equity markets, the year began positively after an awful 2022. European natural gas prices continued to decline throughout the quarter, with January alone seeing a 25% fall. Next winter’s gas contracts are now about 30% below the end-2022 price levels.
Consumer confidence improved as households and small businesses became less fearful of energy-induced inflation. The resilience of the general jobs markets also kept consumer spending at reasonably normal levels.
In China, reopening meant a resumption of firstly domestic travel which boosted services over the Chinese New Year. Then a phased reopening of international travel boosted tourism although this will take some time to feed through beyond South-East Asia.
However, hopes for a strong rebound in construction were not fulfilled immediately. A rebound in metals prices in early January was unwound somewhat in February. March saw a late rally but only to January highs.
The global growth outlook felt generally better throughout the quarter in comparison to 2022. However, central banks remained worried about tight labour markets and the emergence of second-round effects from 2022’s inflation surge.
This meant that short-term interest rates were raised further, continuing at the general pace established in 2022.
The constraints placed on the regional economies has been substantial for people and companies that needed more debt or other forms of capital. Residential and commercial mortgage applications had already fallen globally during the second half of 2022 and remained or even worsened during the first quarter.
Bond issuance for larger companies rebounded however as longer maturity investment grade yields started to fall. Bonds generally were stable overall through the period although volatility remained high. While investors began to sense that the damage done to the vulnerable sectors was becoming significant, economic resilience meant investors were unsure if the peak of rates was near at hand until we entered March. Bond yields traded between the October high and the December low.
However, new bond issues were met with strong investor demand despite fears over creditworthiness in weaker issuers. Demand rose substantially, especially for US Dollar investment grade bonds yielding above 5%.
The second week of March became a defining moment. The problems in cryptocurrency markets which had crystallised after FTX’s demise led to a shut-down of Silvergate Bank, ostensibly because of its involvement in cryptocurrency exchange systems.
However, almost immediately, Silicon Valley Bank experienced a sudden run, with almost all its depositors attempting to withdraw their money. The bank had experienced a number of its start-up tech companies having to draw down on the equity monies raised in the past years after tech funding dried up during 2022. The bank attempted to raise capital to offset the flows but severely misjudged the perceptions of its actions. It sold a portfolio of US treasuries which were designed to be held to maturity at a substantial loss. This convinced depositors that the bank was experiencing a sudden collapse and so they rushed for the door en masse.
While the issues at SVB were quite specific to the bank, investors focussed on possible problems with other US regional banks. In 2018, then President Trump reduced the regulatory burden on these banks which resulted in a significant increase in lending, particularly to commercial real estate companies. The pandemic’s impact on this area has been awful and there appears to be little sign of any improvement.
Indeed, Commercial Real Estate REITs across the globe continue to be shunned. British Land PLC, the UK REIT with 50% of its assets in the City of London saw its share price hit badly hit in the last days of March. Meanwhile private credit funds such as Blackstone’s Office REIT saw large investor selling.
Amid fears that financial stability was at risk, the Federal Reserve pumped liquidity into the US banking system, which stabilised investor fears quite quickly. Indeed, while cash holders moved into money-market funds, big sums were deposited in the major banks.
In the past couple of years, Credit Suisse and Deutsche Bank have been troubled so it was not surprising that investors became concerned that they would face further problems in this environment. Deutsche Bank came under pressure but this passed by quite quickly. However, for Credit Suisse, it was too late in attempts to overcome fundamental weaknesses. The Swiss authorities moved quickly to persuade Union Bank of Switzerland to take it over, the process becoming public just as Credit Suisse’s share price collapsed. The rescue was not with drama, with holders of equity-like assets called Additional Tier 1 “bonds” having all of their holdings completely written off.
The effect of the events could have created a domino fall, just as happened in 2008. However, swift central bank action combined with general resilience of the financial system and no new issues were immediately apparent.
While credit spreads moved out sharply, this was accompanied by a sharp fall in government bond yields. Markets moved to believe that central banks have now reached the peak in the rate rise cycle, and that economies would show only weak growth and inflation for the rest of the year, allowing the potential for rate cuts in fairly short order.
In turn the easing of policy constraints helped equities, especially the larger companies in the US where the flow of earnings is relatively stable. Lower yields increase the current value of the more certain cashflow in the future.
The other dynamic which has become apparent this quarter focuses on the impact of artificial intelligence applications such as ChatGPT. The November release of that particular application has led to a huge media frenzy and many other competing applications being announced. Chip-related companies have benefitted from the newsflow through this quarter. Price-to-current-earnings valuations on those stocks have improved dramatically.
The tremors caused by the demise of Silicon Valley Bank and Credit Suisse have passed quite quickly. This has led to perceptions that, while others may occur, the system and policy response is more robust than fifteen years ago and that there is less to fear. Nevertheless, for many small firms especially, access to capital is still difficult. The events of March cold still have impacts on future consumer and business confidence.
Asset class returns as at 31st March 2023
The text is taken from The Tatton Weekly and is provided by Tatton Investment Management. The information in this document does not constitute investment advice or a recommendation for any product and investment decisions should not be made on the basis of it.
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