While markets seem keen to move on, we likely haven’t yet seen all the effects of the bank shock. As investors, we’re focused on sizing up the impact.
Madison Faller, Global Investment Strategist
Stephanie Roth, Senior Markets Economist
Our Top Market Takeaways for March 31, 2023
Market update
Good riddance to March
This month has seen a lot—three U.S. bank failures (and one in Europe), emergency action by policymakers, hot inflation readings, more central bank rate hikes and a presidential indictment.
Yet markets have, for the most part, shaken it all off. A 60/40 portfolio of global stocks and bonds has returned +5% so far this year.
Tech has been a powerful force, up an astonishing ~20%, thanks to companies with flush balance sheets and strong management teams acting as high-quality havens. Stocks in Europe have outperformed their U.S. peers. And despite wild swings in rates, bonds have proven their value as essential portfolio protection. The power of diversification is at work.
Broad markets have shaken off a lot of the bank worry
This chart shows the year-to-date performance of tech, global stocks, S&P 500, a 60/40 portfolio, global bonds, large banks and U.S. regional banks.
Both all banks and U.S. regional banks fell sharply following the first signs of banking stress on March 8, while broader markets held up relatively well. The year-to-date performances are:
- Tech: +18.5%. The line started at 0 and went up to a high of 17.0% on February 2, 2023, before heading down to a relative low point of 8.1% on March 10, 2023. It ended up at a high point of 18.5% on March 30, 2023.
- Global stocks: +6.0%. The line started at 0 on January 2, 2023, before going up to a high of 9.4% on February 2, 2023, then it headed down and bottomed at 1.6% on March 14, 2023, before bouncing back to the high point of 6.0% on March 30, 2023.
- S&P 500: +5.5%. The line started at 0 on January 2, 2023, before heading up to roughly 9.3% on February 2, 2023, before going down to a low of 1.0% in mid-March 2023. It then rose to 5.5% by the end of the month.
- 60/40: +4.8%. The line started at 0 on January 2, 2023, and peaked at 7.5% on February 2, 2023, before going down to a bottom of 1.6% on March 10, 2023, and recovered to the recent data point of 4.8% on March 30, 2023.
- Global bonds: +2.9%. The line started at 0 on January 2, 2023, and peaked at 4.7% on February 2, 2023, before going down to a low point of -0.6% on March 7, 2023, and then recovered to the most recent data point at 2.9% on March 30, 2023.
- Large banks: -7.8%. The line started at 0 on January 2, 2023, and peaked at 10.7% on February 7, 2023. It then trended down until the recent data point at -7.8% on March 30, 2023.
- Regional banks: -31.8%. The line started at 0 on January 2, 2023, and peaked at 13.8% on February 2, 2023. Then it went down a big decline until the recent data point at -31.8% on March 30, 2023.
That doesn’t mean the coast is clear. When central banks hike interest rates and tighten the flow of credit to the economy, things tend to break. Different parts of the economy tend to break at different times—and this cycle has already seen corrections in housing, manufacturing and tech. Now, it’s banks, which can feel especially bad, given their place at the epicenter of the economy. While markets seem keen to move on, we likely haven’t yet seen all the aftershocks.
Spotlight
The ripple effects of the bank shock
Based on what we know now, this episode doesn’t look systemic, and it doesn’t look like another 2008. However, the cracks are evident, and as investors, we’re focused on sizing up the impact. Here, two questions are key: Are there signs of contagion? And what other pressure points could be lurking?
1) Are there signs of contagion?
The recent shock has left bank customers questioning just how safe the cash is in their checking or savings accounts. That worry has sent deposits rushing out of small banks and into both large banks and money market funds (which invest in things such as low-risk, cash-like instruments and short-term bonds—and often offer higher yields). Over the last few weeks, money market funds have seen their largest inflows since early in the pandemic, bringing their total assets to over $5 trillion (the most on record).
If this trend accelerates, and all depositors demand their money back at the same time, this can put banks in a tough spot. When it happened with Silicon Valley Bank (SVB), the bank had to sell some of its assets at a big loss to pay back its flighty depositors (who were largely concentrated in an interconnected web of tech startups). And it still wasn’t enough. The fear then follows—when confidence in the banking system is shaken, will it ricochet to the point of contagion?
There are promising signs that some of the worry is abating. For one, policymakers have made a big effort to not only backstop failed banks (such as SVB and Signature Bank), but to also provide liquidity to all banks (for instance, through the Federal Reserve’s discount window and new Bank Term Funding Program). This helps ensure banks have the cash on hand to meet the demands of their depositors.
How much these facilities are used can give us a sense of the degree of panic depositors may be feeling and, in turn, the pressure banks may be facing. While banks have tapped the Fed’s and other sources of liquidity, this borrowing now seems to be decelerating (albeit remaining elevated). This suggests that liquidity strains at least aren’t getting worse.
Banks are tapping liquidity from the Fed, but the rate is slowing
This bar chart describes the Federal Reserve’s discount window and how much the Fed lent out through its Bank Term Funding Program (BTFP) in March 2023, as well as the peak usage during the Global Financial Crisis and COVID-19. The unit is in $ billions.
The total sums at each date amount to:
- October 29, 2008 (GFC peak usage)—Discount window: 111
- March 25, 2020 (COVID-19 peak usage)—Discount window: 51
- March 1, 2023—Discount window: 4.4
- March 8, 2023—Discount window: 4.6
- March 15, 2023—Discount window: 153, BTFP: 12
- March 22, 2023—Discount window: 110, BTFP: 54
- March 29, 2023—Discount window: 88, BTFP: 64
The series started at 0.1 in January 2004 and peaked at 110.7 in October 2008, then it came down and touched 0 again in August 2011. It stayed flat near 0 until it spiked again to 50.8 in March 2020 before coming all the way down, and reached 0.2 in September 2021 before climbing to a new high of 152.9 on March 15, 2023, before coming down to 110.2 on March 22, 2023.
For the Bank Term Funding Program, it started at 0 in January 2024 and remained at 0 until March 15, 2023, where it went up to 11.9 and then to a peak of 53.7 on March 22, 2023.
That said, things can change quickly, and banking system stress is still high. If things take a turn for the worse, this begs the question of what more policymakers can do. A number of industry leaders have called for enhancing the FDIC’s deposit insurance, which currently guarantees that deposits are safe if a bank fails—but just up to a limit of $250,000. This means almost half of U.S. bank deposits today are uninsured. But while upping the limit and extending insurance to all banks could reduce the risk of further bank runs, such action is politically contentious and would require action from Congress. It’s possible, but could be a tall feat.
2) What other pressures are lurking?
To keep deposits in the door, banks may be forced to offer higher rates that compete with other banks and money market funds. They also may be more reticent to lend in an uncertain environment. All of this cuts into banks’ profitability—and the upcoming earnings season should provide an initial sense of these challenges.
What’s more, the bank shock has highlighted gaps in existing regulations. Moving forward, regulators will likely take a stricter approach to current rules, as well as introduce new ones in time. Yesterday already brought an example of this, with the White House calling for regulators to tighten their grip on mid-sized banks.
Finally, the impact of the shock isn’t limited to the banking system, prompting many to question what may be the next shoe to drop. Here, it matters who smaller banks have been lending to, and concerns have been growing around commercial real estate (CRE). The sector has already come under pressure as interest rates have risen, but this dynamic is now in acute focus, given CRE makes up almost half of small banks’ loans.
Small vs. large banks: Breakdown of loan exposures
This chart shows the breakdown of loan exposure for small banks and large banks for C&I, Residential RE, Commercial RE, Consumer and Other.
• C&I: 23.1% exposure for large banks and 17.5% exposure for small banks as of March 2023
• Residential RE: 24.1% exposure for large banks and 20.6% exposure for small banks as of March 2023
• Commercial RE: 13.1% exposure for large banks and 42.9% exposure for small banks as of March 2023
• Consumer: 20.4% exposure for large banks and 11.5% exposure for small banks as of March 2023
• Other: 19.2% exposure for large banks and 7.4% exposure for small banks
The most vulnerable area looks like offices. Disrupted by the rise of remote work (which is still 7x of what it was before the pandemic), office CRE is likely to go through a real reckoning—perhaps as serious as the Global Financial Crisis. Yet it’s worth noting that the office subsector represents just ~14% of all CRE (and office construction is just 0.4% of overall GDP). Further, not all CRE is created equal: Segments such as data centers, hospitals, apartments, retail and the like don’t seem to be facing the same pressures. Markets seem to be acknowledging at least some of this difference in risk.
Office REITs have led broader sector declines
The chart shows the price level performance for REITs (represented by the S&P 1500 REITs Index) versus Office REITs (represented by the S&P 1500 Office REITs Index).
The S&P 1500 REITs line started at 74.9 in January 2007, then went all the way down to 20.0 in March 2009 before rebounding all the way to a peak of 128.7 in December 2021 before dropping to the current level of 85.5 as of March 2023.
The S&P 1500 Office REITs started at 100.8 in January 2007 before dropping all the way to a low of 25.7 in March 2009 before bouncing back to a high of 104.3 in February 2020. Eventually, the series ended at a trough of 42.1 in March 2023.
Investment implications
Defensive, not fearful
Even if market volatility subsides, banks will probably lend less—but just how much is still an open question. We tend to be less optimistic, given that small banks have driven the majority of lending over the last six months and also tend to make loans to small businesses, which employ 80% of the workforce. In all, less credit flowing into the economy tends to mean lower growth, and this could accelerate the path to recession.
Small vs. large banks: Contributions to loan growth
The charts shows the 3-month annualized contributions to loan growth from small banks, large banks, and the total of all banks.
The first data point came in at -3.7% for total of small and large banks in January 2021. The total had a peak at 2.8% on March 2021. It then dropped to a low at -1.3% in June 2021. It ramped all the way up to reach a peak at 15.7% in June 2022 before coming down to the recent data point of 6.9% in March 2023.
For large banks, the first data point came in at -2.4% in January 2021 and went up to a peak of 8.8% in June 2022 before dropping to the current level of 1.0% in March 2023.
For small banks, the first data point came in at -3.0% in January 2021 and went up to +3.6% in April 2021 before getting down to a low of -1.0% in July 2021. Then it climbed to a high point at 7.3% in June 2022 and remained at high point until the most recent data point of 6.0% in March 2023.
Tighter credit conditions from the banking sector can do the same job as rate hikes, which means that the Fed probably doesn’t have to raise interest rates as much as it otherwise would have. That said, sticky inflation is still a going concern.
We are focused on investments that are more defensive and can offer protection in a downturn. The quick collapse in yields over the last month demonstrates why bonds are essential. Strategies such as structured notes can help you stay invested in both the good days and the bad, through protecting gains and building in a buffer from adverse moves lower. Sectors such as reasonably priced technology, healthcare and industrials could be bellwethers as other cyclical parts of the market struggle. And as growth grows more scarce in the United States, prospects in Europe and China look a bit better.
Above all, stick with your investment plan. History suggests that this too shall pass, and investors are less likely to suffer losses over longer periods—especially in a diversified portfolio.
Your J.P. Morgan team is here to discuss what it all means for you.
All market and economic data as of March 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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