Market Musings
Hello everyone,
It's been a while since we sent you our thoughts in writing. Current events and their effects on the markets give us little respite these days. Here is a summary of recent events. Please forgive us for omitting a few subjects since we try to keep these comments brief. We believe it is worth reading until the end.
U.S. Regional Banks
You've probably seen the headlines about the recent bankruptcies of Silicon Valley Bank (SVB) and Signature Bank, commercial banks that were taken over by U.S. federal regulators two weeks ago. Although the U.S. government is taking steps to reassure investors, it is understandable that these two bankruptcies raise concerns. While the future of these companies and their assets is not yet fully determined*, we wanted to address some of the apprehensions you may have about these events.
First, we want to reassure you that Raymond James is well positioned to weather changing market conditions. Our firm has always been committed to prioritizing risk management and long-term results over short-term gains. This approach is exemplified by our parent company's 140 consecutive quarters of profitability, which span several recessions and tough markets, including the financial crisis of 2007-2008. Moreover, not being a bank (great advantage in this context and excellent reason to do business with us), Raymond James is much less exposed to interest rate movements and not subject to a “bank run” (potential mass withdrawals from its depositors).
Let's take a few minutes to remember how a bank works in its simplest form: banks use leverage. It has been their bread and butter since the beginning of time. On the one hand, they receive deposits on which they pay an anemic interest rate and on the other hand, they lend up to 10X (and unfortunately, sometimes, more) the equivalent of this amount to borrowers, for an interest rate much higher. When all is well and the future is bright and predictable, this strategy is very profitable. On the other hand, during a massive withdrawal by depositors (stimulated by rumours on social media, for example), when more and more borrowers are in difficulty of payment because of the steep rise in interest rates, the bank finds itself in financial difficulty. This is basically what happened in the case of SVB. They say it’s an isolated case in a way, since the clientele of this bank was very concentrated in high-tech companies with little or no income. Fortunately, our major Canadian banks have a more diverse customer base and more varied lines of business than SVB.
Banks Again
The Credit Suisse, following a proud 167 years of history and being the second largest bank in Switzerland after UBS (and once the largest), has literally collapsed. The regulators, in a hasty and unexpected decision, implemented a forced merger between the two behemoths of Swiss finance, two competitors, lifelong "enemies". UBS was thus able to get its hands on Credit Suisse for a pittance. Credit Suisse's troubles matter more to the global financial system than the tiny (in comparison) SVB. On the other hand, this transaction is a good omen in order to limit contagion. Moreover, the difficulties of Credit Suisse and several other European banks is nothing new. It is not uncommon to hear strategists and analysts mention that these banks have been on life support (we have even heard the comment “insolvent” from some market participants) for 6-7 years, or even since 2008-2009, for some. Deutsche Bank also appears to be in critical condition. To be continued...
Economy
Short-term interest rates continue their dramatic rise, with their impact on consumer sentiment beginning to be felt. The U.S. Federal Reserve raised its key rate by a quarter of a percentage point last Wednesday, slightly less than the half point expected for a month. The Bank of Canada, which had announced a pause, could decide to follow the United States and also raise rates to avoid an excessive devaluation of the Canadian dollar. So-called devaluation, which contributes to inflation (still public enemy number 1). On the other hand, in the wake of the current banking problems, investors are beginning to wonder how far central bankers are willing to go in order to calm inflation. And, will this rate hike really have that effect? Will this fast rise in rates start to have more serious and exponential repercussions on the real estate market, then ultimately on the job market? If interested, please take a look at this link, detailing some of the current announcements about job cuts, underway or projected, in the U.S.: https://www.forbes.com/sites/brianbushard/2023/03/27/2023-layoff-tracker-disney-starts-cutting-7000-employees/?sh=12d8ccaa301e.
We recently read that the Huot Group, one of the largest real estate groups in the Quebec region, is in financial difficulty. The rise in interest rates (especially) along with the shortage of labour and the cost of materials put enormous pressure on the company. This sector could be hit hard and only companies with impeccable balance sheets and sound management will be able to weather the storm without too much damage. To be continued.
Geopolitics
Chinese spy balloons flying over America, U.S. drone shot down by Russian plane in international waters, NATO Poland donates fighter jets to Ukraine, President Xi Jinping's cordial visit to Vladimir Putin (now officially a war criminal) on Russian soil, the return of Donald Trump, demonstrations in Israel against Netanyahu's judicial reform and in France, against pension reform... In short, rather calm on this side.
Sarcasm aside, at this point, we were hoping for some sort of resolution to the conflict in Ukraine, but unfortunately, tensions are at their peak. The visit of the Chinese president could have been perceived as some step towards peace, China proposing an end to the conflict, which would put them in a position of strength (saviours?) on the international scene. On the other hand, it still seems utopian to us, at this point, that Ukraine would accept a compromise that would concede anything to Mr. Putin. To be continued.
Conclusion
Our positioning remains defensive. We continue to find bonds with attractive yields in the short term (thanks to rising interest rates!) and remain invested in stocks of companies that we believe will better weather the upcoming markets that we expect to be rocky for the markets. We are also on the lookout for opportunities that emerge in this type of environment. If you have any questions or concerns, please do not hesitate to contact us.
We wish you a good start to spring.
Guillaume, Erik and your Patrimonia Wealth team
*On March 27, First Citizens Bank, another larger U.S. regional bank, acquired SVB bank. https://www.cbc.ca/news/business/svb-first-citizens-bank-collapse-1.6791923
Disclaimer
Erik Moisan and Guillaume Desjardins-Tessier are Portfolio Managers with Raymond James Ltd. The views are those of the authors, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member - Canadian Investor Protection Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual funds. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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