The implications of SVB

• Risks to financial stability stemming from the turmoil of US regional banks, such as Silicon Valley Bank (SVB), are back at the forefront and are reshuffling the monetary policy outcomes for the Federal Reserve (Fed).
  
  
• Following the fallout of SVB and the joint support announcement of the US Treasury and the Fed to limit bank runs, the likelihood that the Fed will increase interest rates later this month is falling. This is also leading to growing uncertainty on the policy path beyond the March meeting. 
  
  
• For now, the fall in SVB prices appears to reflect risks specific to them rather than systemic ones. SVB serves California’s tech industries and grew fast alongside those firms during years of low interest rates. But higher interest rates, rising macroeconomic uncertainty, declining venture capital and private equity investments and high cash burn rates amongst SVB’s clients put stress on the firm. 
  
  
• In short, we believe it’s unlikely that this is a liquidity crisis as SVB faces a liability issue (investing deposits rather than making loans). Most US banks are generally asset-sensitive and, hence, benefit from higher interest rates. In addition, regulations put in place since 2008 have reduced the risk of a systemic banking shock. 
  
  
• Economic data will now take a backseat until the financial sector settles down. The US inflation release due on Tuesday would have been key in determining the size of the next hike. Now the inflation data carries an uneven balance of risk. A stronger-than-expected print may be ignored by markets while a lower-than-expected print could further support the bond market. 
  
  
• Overall, financial stability risks highlight the challenges policymakers face at elevated policy rate levels. Namely, the unintended consequences of policy tightening (mostly for zombie companies) and recession risks (the yield curve remains deeply inverted but has steepened as evidenced by the 2/10 year US Treasury yield spread rebounding from -100 to -60, potentially signalling growing risks). 
  
  
• The European Central Bank (ECB) reconvenes on Thursday with a pre-signalled 50 bps hike. It’s unclear if US banking jitters could deviate the ECB from hiking further in May. ECB policy normalisation looks set for now to support the EUR. 
  
  
• Elsewhere, Xi Jinping was confirmed for an unprecedented third presidential term. We continue to believe that China’s reopening will benefit Asia-Pacific first.

• As legendary investor Warren Buffet put it, “only when the tide goes out do you discover who's been swimming naked.”
  
  
• We have been in an inflationary environment since Covid and, to bring inflation under control, central banks have hiked interest rate rapidly to bring down demand. This backdrop has recreated pockets of weakness in economies (property, durable goods) and has created recessionary fears. In this environment, one wants to mostly invest in companies that are 1) either self-sufficient with plenty of cash in the balance sheet to steer their business through challenging times and/or 2) that have a business model less exposed to exogenous shocks. 
  
  

Here’s how we’re positioned in our flagship portfolios:

• We have previously spoken about the quality-growth bias of our strategy. Since the summer of 2022, we have increased the quality of the investments in the portfolios further whilst reducing the growthier element, for example technology. 
  
  
• Last week’s events affecting the US banking system related above are a reminder of why quality matters. The first market reaction has been positive for US Treasuries (we are overweight US Treasuries) and negative for the US dollar (we expect the USD to fall over the course of 2023). Equity markets are currently sitting on a seesaw - downside risks vs policy support – which underscores our underweight equity positioning, with a focus on quality. 
  
  
• Additionally in our portfolios, more meaningfully in our cautious risk-profiles, we hold gold as a defensive asset which, alongside high-quality bonds, has also performed positively in this risk-off market. 
• Finally, we believe China’s continued re-opening (supported by Xi Jinping’s re-election) could benefit our overweight position in Asia-Pacific equities. 

Past performance is not a reliable indicator of future returns.