Since late last week, there has been a bit of market turmoil related directly to the banking sector; more specifically, that federal regulators closed the 16th largest bank in the US, Silicon Valley Bank (SVB).
There is more than a little media coverage of the situation, so we won’t over-editorialize the situation or get too granular with the details specific to SVB; however, we want to provide some high-level understanding of what is happening and talking points for investors.
Generally speaking, the way banking works is banks take in short-term deposits from customers and use those deposits to make longer-term loans. In recent years, saving rates have been high, and as a result, there have been fewer loans to put collected deposits to work in; consequently, many banks put the money to work in investments. Many of these investments are longer-term treasuries that fluctuate in value day to day.
This strategy is fine, provided the investments are held to maturity because day-to-day fluctuations are meaningless if you don’t sell. However, should customer withdrawals exceed cash on hand for the bank, some securities must be liquidated (prior to maturity) to cover the withdrawals – potentially at a loss.
That is what happened here. SVB had to liquidate investments to cover withdrawals, but they had made investments in securities that were in appropriately risky, and that risk was intentionally unhedged.
As word got out that this was happening, it quickly became a self-perpetuating snowball. Nervous customers start withdrawing more money, the bank liquidates more investments at losses, lather rinse repeat – enter bank run.
What does this mean for investors?
Long-term, hopefully, nothing. It is tempting to connect what is happening here to what happened in 2008 when the banking and financial services sectors were on (or past) the brink. However, it does not appear we are in that situation. SVB is in trouble, and almost certainly there will be other banks in the same situation that follow suit. Markets in the short term can be unforgiving in these situations; however, the banking industry is in a much different shape than it was in 2008 (it is as strong as it has been in a long time), and the players involved are dramatically different and less impactful to banking and the general economy than those of 2008. It does not appear that this is a systemic issue with sector-wide ramifications.
So as an investor, fear and greed likely will dominate responses to the news. The pessimist may want to flee for fear of a prolonged market downturn. The optimist may view this as an overreaction and want to capitalize on the moment. The appropriate response is probably neither. Stay the course. Timing these things well will be difficult.
Your Evidence Based Portfolios are extremely diversified and intentionally not concentrated on any individual company or sector. Exposure to SVB directly is a fraction of a percent for our investors – relatively insignificant. This would be true for nearly all holdings in the portfolio. In the short term, there will likely be volatility that investors are exposed to, which stings at the moment but is not terribly harmful to investors that stay the course (stay invested) long enough to let the volatility and noise work through the system.
This is the risk and volatility that, as an investor, we are compensated for and markets are expected to reward us over the long term if we endure. Your portfolio was built to handle volatility and shocks to the system. It was not built to handle poor investor behavior and emotional reactions. This is what can hurt your portfolio in the long term.
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