April 2023
Does history repeat? We believe today’s upset in financials isn’t new territory – but neither does it seem like it’s a rerun of 2008. Here’s why.
Bailouts, bank failures and government interventions – it’s easy to see why March 2023 is reminiscent of Autumn 2008. But just because the words are the same, evoking such a difficult time doesn’t mean history is repeating itself. Although it may just be that 2008 is responsible for what is happening today.
Over 15 years after the Global Financial Crisis (GFC), sparked by the collapse of a bank, the world is once more in a rising interest-rate environment and fighting inflation. Investment experts across BNY Mellon Investment Management point out that with interest rates rising alongside costs, it’s little wonder some companies are struggling to service their debts.
Source: Macrobond, BNY Mellon Investment Management. Data as of March 24, 2023. The Chicago Board Options Exchange Volatility Index (CBOE VIX) is calculated in real time and measures the expected volatility of the S&P 500 Index options over the next 30 days. Past performance is not a guide to future performance.
But while the market volatility and bearish sentiment created by the March 12 collapse of the US regional Silicon Valley Bank (SVB) and the March 19 “emergency” takeover of Credit Suisse are concerning, investment professionals argue this isn’t 2008.
Shamik Dhar, chief economist at BNY Mellon Investment Management, notes in both cases (SVB and Credit Suisse) it was concerns about the profitability of the banks that triggered a “run” by depositors.
Roy Leckie, executive director at Walter Scott, notes the backdrop for banks was already looking fragile ahead of SVB:
“We have been through an extraordinary period of monetary stimuli since the GFC, and corporate debt has been rising. There are plenty of sub-par businesses, bloated with debt, whose returns and financial health have been propped up by cheap financing. More expensive money may pose a threat to these businesses, leading to a deterioration of the nonperforming loan picture and therefore a dilution of the beneficial impact of rising interest rates and economic growth.”
Newton’s Real Return team says: “SVB operated in a niche area of lending and Credit Suisse’s financial performance had been sub-par for some years. Still the ripple effects of recent events are causing widespread unease and stress in markets. It has also led to fears that other signs of fragility may emerge. “Rising interest rates have highlighted financial strains, and management teams caught on the wrong side of a less benign monetary environment have struggled to navigate this challenging situation. But financial leaders have moved swiftly to try and contain any fallout and pre-empt any further contagion. It remains to be seen whether this will be sufficient.”
Euan Munro, chief executive officer of Newton Investment Management stops short of comparing today’s market backdrop to 2008:
“Questions around whether we are entering a new 2008-style banking crisis are not without a total lack of merit, although in our view, this is not the case. Bank capital rules imposed after 2008 have ensured the capital positions of most within the sector remain strong and credit quality remains robust. Such reassurances may have been lost in the face of the market panic afflicting bank shares.”
“The bullish assessment that there is little fundamental reasoning to distrust the viability of European and UK banks is certainly being outdone by bearish sentiment. Credit losses are low and capital levels strong, so the likelihood that the collapse of Credit Suisse and regional US banks is indicative of what’s to come appears overblown. Yet, central banks do now have less maneuverability than they did in 2008 should the rising-rate environment start to eat into capital buffers.”
Martin Chambers, credit analyst at Newton Investment Management, points out banks are very cyclical beasts. As such, if anyone is suffering from the higher borrowing-cost environment, it is sure to be felt by the banks. While Chambers says he would not rule out a financial crisis completely, he does not believe this is a rerun of 2008 “in any way.”
He says: “In terms of financials, we do not believe this is a systemic issue. We see Credit Suisse as an isolated, idiosyncratic issue within the European banking space. It was unprofitable and poorly managed for a number of years, with clear control deficiencies. While we did not expect it to go under, it was long seen as the weakest link among the major European banks. In terms of the broader market, while we appreciate that as central banks raise rates there are likely to be higher arrears and defaults within loan books, banks are generally well capitalised and well managed, so we see this as more of a hit to profitability rather than a balance-sheet issue.”
But that’s not to say the impact of the rising-rate environment won’t continue to be felt by markets. “There could be a number of companies out there who have been bolstered by very cheap borrowing costs for a number of years who may now find conditions more challenging.”
As such, Chambers expects a European recession this year. Dhar agrees and believes the tightening credit conditions may also be sufficient to send the US into a (mild) recession later this year.
OPPORTUNITIES?
Amid many volatile and uncertain market environments, the appeal of sovereign debt rises. We believe that this time is no different. Chambers notes that while there may be pockets of difficulties in some high-risk credit resulting from the March volatility, there is sufficient liquidity within the sovereign-bond space.
Dhar says in this environment he expects risk assets to be under pressure. However, he remains relatively positive on fixed income assets. He says: “The fixed income opportunity set is arguably more attractive than any seen in decades. And while compensation for taking duration risk remains low (many yield curves are inverted), we argue that attempting to precisely time the next big yield curve move should be avoided. Markets can move quickly and unexpectedly, as highlighted by the March banking sector drama.”
“Staying defensive and nimble translates more specifically into a preference for cash-like and sovereign bonds that currently offer attractive yields. Our latest forecasts make us somewhat more cautious on credit exposure due to the possibility that spreads widen considerably during a recession. Remaining up in quality and pairing with active bond selection will be needed to successfully manage credit risk. We continue to prefer investment grade to high yield.”
Dhar adds that amid the current uncertainty, he believes a sensible multi-asset approach is to be balanced, well diversified, and defensive in portfolio allocation while maintaining the ability to be nimble as the economy evolves. “Portfolio resiliency, the ability to withstand and thrive under different market environments, will be key.”
Source: Macrobond, BNY Mellon Investment Management.
Eurex Exchange, ECB (European Central Bank), Intercontinental Exchange (ICE), Bank of England, CME Group, Federal Reserve Bank of New York.
Data as of March 24, 2023. Past performance is not a guide to future performance.
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MARK-365967-2023-03-30. T11394 04/23