The banking system relies on confidence, and that’s being shaken—but we think policymakers have the tools to navigate the turbulence.
Our Top Market Takeaways for March 17, 2023.
Market update
Everything, everywhere, all at once
All businesses go through times of struggle. When it’s banks, it feels a whole lot worse.
The near-simultaneous collapse of Silicon Valley Bank, Silvergate Bank and Signature Bank last week challenged confidence in the financial system. The swift and coordinated move on Sunday night by the FDIC, Federal Reserve and Treasury to reassure bank depositors was a powerful effort to instill calm. Nonetheless, investors didn’t find much reprieve until the Swiss National Bank and a consortium of U.S. banks stepped in to support Credit Suisse and First Republic, respectively, later in the week.
The swings in markets have been eye-watering: Each day this week has seen 2-year Treasury yields whipsaw more than 20 basis points (bps) in either direction, and bond volatility spiked to the highest it’s been since the Global Financial Crisis. Banks saw their worst day since March 2020 on Monday, while tech is having its best week since November.
Somehow, through everything, everywhere, all at once, the S&P 500 is heading into Friday +2.6% higher on the week.
It’s unlikely this all will be resolved this week, or even this month. We wouldn’t be surprised to see more aftershocks. For now, we focus on what we know.
Yesterday marked one year since the Fed’s first rate hike, and since then, it’s increased its policy rate by 450 bps—the most aggressive tightening cycle we’ve seen in decades. The banking turmoil seems like the latest symptom of this historic policy tightening.
We expected higher rates to have consequences, and to tilt us into a recession this year. Rate hikes are meant to slow growth and inflation, and they leave damage along the way. For months, different parts of the economy have corrected in the face of these challenges (housing, manufacturing and tech have all gone through their own reckonings over the last year), and now the banking sector is the latest to stumble.
Granted we didn’t expect three regional banks to fail, and it seems the breakdown from higher rates is happening faster than we expected.
Some good news: It’s clear that policymakers are taking the risks seriously.
The contagion, wealth destruction and job loss experienced during the Global Financial Crisis (GFC) are etched into memory. We have confidence that policymakers developed a powerful playbook 15 years ago and are deploying it more rapidly this time around. The quick and sweeping moves from U.S. and Swiss authorities to support banks over the last few days demonstrate this commitment.
What’s more, the banking sector as a whole is in a different place today. The largest and systematically important banks are more regulated, tend to have diversified deposits, maintain fortress balance sheets, and as a result, are much better capitalized now. That’s not to say there won’t be further stress, but it does make comparisons to 2008 an incomplete analogy.
As a whole, the financial sector is well capitalized
This chart shows regulatory Tier 1 capital to risk-weighted assets (%) in 2009 and 2022 by country: • Italy: 8.3% in 2009 and 16.1% in 2022 • Spain: 9.3% in 2009 and 14.5% in 2022 • France: 10.2% in 2009 and 16.4% in 2022 • Germany: 10.8% in 2009 and 16.6% in 2022 • United States: 11.5% in 2009 and 13.5% in 2022 • United Kingdom: 11.6% in 2009 and 17.6% in 2022
As for what’s next, focus is firmly on how the Fed navigates these new stresses at its policy meeting next week.
Central bankers are now tasked with balancing both the fight against inflation and the need for financial stability. A properly functioning banking system is needed to transmit its own policy.
Before this week’s turmoil, it seemed like the Fed might need to keep pressing on the brake. It was only a week ago that Chair Powell suggested the pace of rate hikes could accelerate to beat down sticky inflation.
But now, this latest shock means the cost of credit is higher and lending standards are tighter, making the decision to borrow, invest and spend more complicated. These dynamics ought to slow growth and inflation, and potentially accelerate the path to recession. As a result, we’re likely now in the final stretch of the Fed’s rate hike process. Looking ahead to its policy meeting next week, markets are split between whether we’ll see a final 25-basis-point hike, or none at all.
March madness, indeed.
Expectations for Fed policy have swung wildly
This chart shows the implied fed funds rate on March 8: Post-Powell, the current one (March 17, 2023), and March 13: Bank rout deepens. The March 8 line begins at 4.57%, rises to a high of 5.69% by September 2023, then falls to 5.44% by January 2024. The current line begins at 4.57%, rises to a high of 4.95% by May 2023, then steadily falls to 4.11% by January 2024. The March 13 line begins at 4.57%, rises to a high of 4.77% by May 2023, then dips to 3.8% by November 2023 and 3.7% by January 2024.
Investment considerations
Steady hands prevail
Investors will continue to question the path forward, with more market swings ahead—but in the meantime, we believe the best course of action is to stay balanced, focus on the facts, and be prudent.
To us, this means a few things:
1) Not taking big swings
When it comes to times like these, steady hands prevail—and that means not overreaching for risk. That’s why we’re more closely tracking our benchmark in the core portfolios we manage, and focusing on high-quality investments rather than speculating.
2) Getting defensive, especially with bonds
The quick collapse in yields over the last week demonstrates why bonds are an essential part of a diversified portfolio. While markets may still be searching for calm, we expect rates to finish the year even lower as recession takes hold, or future stresses reveal themselves. This means bonds can offer essential protection.
The Great Financial Crisis (GFC), for instance, was no exception: A portfolio invested 100% in global stocks at the peak of the market before the crash would have seen steep losses of ~60%. Meanwhile, a portfolio invested in 40% global stocks and 60% global bonds would have suffered losses half as great—and only taken half the time to recover.
GFC Case Study: Diversified portfolios recovered at a faster clip
The chart depicts the portfolio returns of a $100,000 investment into the MSCI World and the hypothetical portfolio with 60% invested in Equity (MSCI World) and 40% invested in Fixed Income (Global Aggregate Bond Index), and another hypothetical portfolio with 40% in Equity (MSCI World) and 60% in Fixed Income (Global Aggregate Bond Index) from October 2007 to May 2015. For MSCI World, the hypothetical investment of $100,000 decreased in value during the financial crisis to a low of $41,105 on March 9, 2009. From there, it went up and recovered back above $100,000 for the first time on February 28, 2014. Then the series kept going up and ended at $105,857. For the 60% Equity (MSCI World) and the 40% Fixed Income (Global Aggregate Bond Index) portfolio, it also started at $100,000 of hypothetical investment and declined to a low of $60,272 on March 9, 2009. From there, it bounced back and recovered above the original investment of $100,000 for the first time on September 7, 2012. Then it went further up and ended at $119,101. For the 40% Equity (MSCI World) and 60% Fixed Income (Global Aggregate Bond Index) portfolio, it also started at $100,000 of hypothetical investment and declined to a low of $72,357 on March 9, 2009. From there, it bounced back and recovered above the original investment of $100,000 for the first time on September 22, 2010. Then it went further up and ended the series at $124,160.
3) Resisting the temptation to hit “sell”
Market timing can be a dangerous habit, and herd-following behavior during downturns or bubbles can lead to losses. History shows that the best days and the worst days for the market tend to cluster together: Over the last 20 years, seven of the 10 best days occurred within just about two weeks of the 10 worst days.
Missing those best days can have dramatic consequences. For instance, over that same 20-year period, the S&P 500 saw a 10% annual return. But if an investor missed just the 10 best days, that return would have been nearly cut in half.
Stay invested through the good days and the bad
The chart describes the annualized performance of a $10,000 investment from February 2003 through February 2023. Returns are based on the S&P 500 Total Return Index. It states that if the investor stayed invested from February 2003 through February 2023, then the investor would have made 10.27% in annualized return. If the investor missed the 10 best days of the S&P 500, then the annualized return of staying invested for the rest of the time would have become 6.05%. If the investor missed the 20 best days of the S&P 500, then the annualized return of staying invested for the rest of the time would have become 3.37%. If the investor missed the 30 best days of the S&P 500, then the annualized return of staying invested for the rest of the time would have become 1.22%. It also says on the chart that “seven of the 10 best days occurred within 15 days of the 10 worst days.”
Navigating these times can be challenging, but steady hands prevail. Your J.P. Morgan team is here to discuss what it all means for your portfolio.
All market and economic data as of March 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
The KBW Bank Index is a modified cap-weighted index consisting of 24 exchange-listed National Market System stocks, representing national money center banks and leading regional institutions.
For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.
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.
RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative, as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
