March Madness: Bank Turmoil and How it Impacts You -- Jarvis® Update March 17, 2023

We know it's March Madness, but are we talking basketball or the banking system? We answer this question and more on this week's Jarvis Update. I'm your host, Brian Dress, Director of Research here at LeftBrain, joined as always by our Chief Investment Officer and CEO, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian.

We got a lot to cover. But before we do that, we'd like to ask you to like and share the video. If you do find the content useful, it helps other investors find it. It definitely helps us out. And also subscribe and hit the bell for notifications. That way you find out every time that we're out with a new video and we're out on a biweekly cadence now. Markets did actually handle the difficult news of the bank— of the bank runs this week pretty well. Two topics as we discuss this week's market activity. The first is the bank runs. Is it a repeat of 2008? And then the second is growth and tech stand out. A couple of announcements for you before we get started. First of all, we produce the show for you, the individual investor, whether you have a 401(k) or an IRA. If you manage your own money or you work with an advisor, we'd love to be a resource for you. If you'd like a second opinion on how to position yourself in a volatile market, we'd love to talk. Give us a call on the number below and we'd be happy to have a conversation. Also, we've got something for you if you're an institutional investor as well, and that's our research service. We put out 6 to 8 of our full-length reports from our analyst team every month, as well as our quarterly report, The Chosen. That's our favorite stock and favorite bond idea for, uh, for each quarter. So click the link below if you want to get involved with that. We've got a library of hundreds of reports. Either way, please sign up for our monthly newsletter, the Jarvis Newsletter. We were out last week with our last installment and we were calling that Planting Seeds in 2023, talking about the way we're approaching markets. We're gonna jump right in with the market recap. The S&P was up 1.1% this week. The Russell 2000, that's the small cap index, was down 3%. Pretty heavy in financials over there. Um, and also we wanted to say the NASDAQ was up 3.3%, actually led the way this week, which is a little different than what we've seen in the last few weeks. Market was coping with some difficult news. Interest rate volatility is quite dizzying. 2-year US Treasury was up above 5% at the beginning of March. Dropped all the way below 4% in just a week, back a little bit above 4%. But it's still pretty incredible what we're seeing. 10-year Treasury was up above 4% for a little while there, pretty stable, dropped below 3.5% this week. Again, a little bit over 3%, 3.5% this week. But as you can see on the chart, quite a bit of movement. Nolan, any thoughts about this week's action? Is the move in rates just a flight to safety or is it indicative of something else?

Yeah, we've got craziness. We've got March Madness in the markets in spades. In March. My goodness, we got St. Patty's Day coming up, and then in 2 weeks we got April Fools coming up, and it feels like April Fools came early. Those moves in the markets and in interest rates are just breathtaking. And I don't know that we've had a recording where we've seen this level of divergence in the markets. The small caps down 3%, NASDAQ up 3%. This is, uh, lunacy. It's crazy, crazy, crazy. But I guess there's nothing like a good old-fashioned bank run, a global bank run. We had the Credit Suisse news over in Europe. Nothing like that to get the volatility moving and to get the arrows pointing in every which way. So exciting times in the market. It's going to bring up some really interesting opportunities. We're seeing them in the stock and the bond markets. Short term, things may be a little bit batty, but over the intermediate term, I think there's some moneymaking opportunities. So that's the good news.

I agree, Nolan, we're gonna get into that as we get into the meat of the program, but we'll jump in first of all to topic 1. So topic 1, we're calling A Good Old Fashioned Bank Run: Should We Expect Contagion? Beginning of the week, we saw the collapse of Silicon Valley Bank after depositors pulled out billions and billions of dollars from that bank. A number of other banks came under pressure this week. We had Signature Bank, we had First Republic in the US, and as Nolan mentioned, we also had Credit Suisse facing some difficulties over in Europe, in Switzerland. The Regional Banking Index, that's ticker KRE, we're gonna put it up on the screen for you, absolutely crushed over the last month, down almost 30% in the KRE Regional Banks. So that's a pretty huge move, obviously, in a month. Nolan, everyone remembers 2008 fairly vividly, at least I do, and I'm sure you do. Are we looking at a similar situation here with the bank runs that we saw this week? Should we worry about contagion, or do we expect things to be a little more contained than they were in the global financial crisis?

I'm going to go out on a limb here and say I don't think so. This doesn't ring like a 2008 did. So just remember the household names, the 100-year-old institutions that sunk at the time, Lehman Brothers, Washington Mutual, AIG, Freddie Mac, Fannie Mae, which were both quasi-government institutions, Wachovia, the list goes on and on. So this is not that. Also, the banking system's a lot healthier as a result of Dodd-Frank, which was legislation that was put in on the backs of, the financial calamity that happened in '08. So this is a sort of a weird dynamic. There's a lot to unpack here. I don't know that we can do it all in just a couple of minutes. But what drove Silicon Valley Bank under, it wasn't bad lending or anything of the sort. It's a specialized institution that specifically lends money to Silicon Valley startup tech firms. And these firms, they don't actually earn money yet. They actually burned cash. So what ended up happening is Silicon Valley, they had deposits, and for them, they invest deposits like every bank does in the most safest thing that you could buy, which was US Treasuries. Now, when interest rates went up, those Treasury bonds had to be marked down on their books. Not a problem if you're planning on holding those Treasury bonds to maturity, they're probably safer than cash. The problem is when all of these small startup companies needed cash and they needed to withdraw their money from the bank, the bank then had to go take a look at its bond portfolio and liquidate it in order to generate the cash that the depositors needed. And that's where the problems began. So very different than what happened in '08 with a bunch of bad lending and other type of liquidity issues.

Thanks for that explanation, Nolan. I know we've got a lot of clients. There are a lot of people, investors out there with cash in the bank, not necessarily at some of the big four institutions, but, you know, a lot of these regional banks that we just mentioned were down so much in the last month. I guess the question a lot of people are asking is, should they be concerned with the money that they've got sitting in the bank right now?

This is— it's interesting how things are distorted. I remember in the wake of Dodd-Frank in '08, you know, pretty much everything condensed into— now you have big four big depository institutions in the country, and I think we all know who they are. So much so that they had to make a deposit cap at 10% of deposits. I remember Wells Fargo was bumping up against the cap. The regulators don't want this level of concentration, and we get this term too big to fail from the banking institutions. So I know as a country we want smaller regional midsize banks all across the country. It actually makes the banking system safer, but not today. I think if you're you bank at some local hometown bank. Um, and from what I understand, a lot of banks, not every bank has FDIC insurance, if you could believe it or not. So I think if you're not at one of the big four institutions, I think you're right to probably take a look and make sure your bank is FDIC insured. If it is, you have coverage up to $250,000. But if you have more than that at one of these smaller regional banks, you're going to want to reconsider what you're doing with your cash. I don't think it's a systemic issue. I think it will, it will be contained. We're not at the end of it yet, though. I imagine the regulators are very busy right now pouring over the books and records of the thousands of banks in the country to make sure that there's no more boogeyman hiding in the books. So over the next weeks, you're probably going to hear about more companies and capitalization. But I think eventually we'll get through that and they'll get this thing worked out. But we're probably going to see more headlines here over the next few weeks.

Okay, Nolan, let's talk about the implications of all this. How do you expect all this to impact rates, interest rates, and inflation going forward? I know we've been in a huge tightening cycle from the Fed with rates going higher and higher over the last year. Is this going to change that?

Yes, in a word, yes. You know, we've been saying here for the last couple of months that the inflation gauges that the Feds are looking at are backward-looking, and then inflation has peaked and it's coming down. Now, it's not coming down fast enough. A couple weeks ago, we got some pretty sticky core CPI and PPI numbers that had people scratching their head about the direction of rates. I think this sort of seals the fate of interest rate increases. You can pretty much put a fork in that. And what's happening at the bank is certainly deflationary. I think expansion for most businesses is off the table, primarily because lending— you know, if you're one of these small and mid-sized companies, you're not going to tie a bunch of capital up in lending. So lending is going to be harder to come by. So even if companies want to expand and cash isn't available in their account on the bank, I think that's off the table. And from what we understand from listening to these quarterly earnings calls, even before this bank run here the last week or so, companies that already pretty much packed it in as far as growth goes, you know, you're starting to see companies lay off workers, cut expansion plans, and they're focused on profitability. That itself is deflationary. And so I think the interest rate increases are going to be a thing of the past. We're going to have a Fed meeting next week They will do something next week. We're not sure exactly what or how much. And I think that's the beginning of the end. And that's probably why we've seen these aggressive interest rate moves this week to the downside.

Okay, Nolan, that's enough macro talk for the week. Let's move on to topic 2. So topic 2, we're calling Growth Finds Its Footing. So growth stocks did top out a little over 2 years ago in February of 2021. They've languished since. We've been growth investors here for years and it's been a difficult time in that segment of the market. Things have been different so far in 2023. Things have started to look up a little bit more in growth and in tech. This week it was in sharp relief, as Nolan mentioned, with Nasdaq being up over 3%, Russell being down over 3%, significant outperformance there, major divergence. A couple of areas that we've seen that have caught a major bid in 2023, cybersecurity and semiconductors. At the same time, we also recall the relationship between higher rates and lower growth stock prices. So, Nolan, we're starting to see rates starting to tick down. So maybe we're going to see the inverse of that on the way back. How do you interpret what we're seeing in growth stocks so far this year, and what is your outlook, and what should investors be looking to do?

It's a bull market in growth, and I know investors don't want to hear that. I know most investors were already pretty tepid about the investment landscape coming into 2023, especially coming off that horrendous 2022, and most investors are thinking safety. So they don't want to hear that it's a bull market in areas of the market that are more racy, more growth-oriented, more uncertain. Some people call the volatility there that these shares are more risky, but it doesn't look that way to us. It is a bull market in growth, and I think for good reason. One of the reasons that we're heartened about the investment landscape this year is if people were really terrified about global economic recession— is it going to be a short one? How deep is it going to be? But if you look underneath the headlines, you just look at securities prices, investors aren't pricing that in. If you look at the flight-to-safety trade, whether it's consumer staples, dividend stocks, financials, or traditional value stocks and healthcare, they have underperformed this year. So that— and utilities as well. So that tells you that investors aren't seeking safety there. Investors are looking for opportunity and growth stocks is it. So no matter what you're doing as an investor, you want to have exposure to something that will do much better over the next 2, 3 years than it is today. And that means growth. So things that are growing their revenues 15 or 20%, particularly at a time when the economy's stuck in the mud, those type of profiles of businesses, it's easier for them to stick out in a slow growth environment. And if interest rates are actually starting to come down, that was one of the things that put boot on the neck of valuations going back 2 years ago. But if interest rates have crested, it's not a headwind anymore. It's a tailwind to growth shares. And that's exactly what we're starting to see as we're through the the fourth quarter earnings release season.

Thank you for that, Nolan. And we also want to bring back to everyone's attention, markets are forward-looking. So, you know, you can't just look around what the economy is doing today. We got to think about 2024, '25, '26, and beyond, because we're looking to be long-term investors and hold stocks for 5, 10 years. With that being said, Nolan, we like talking stocks and securities here. Anything that stands out for you in growth?

There's a couple of names that I'm going to point out that we kind of been back and forward with. Over the last couple of years, there's a lot. I am more bullish today than I've been in, in really a couple of years. There's a lot of really good businesses. So just a couple of themes. I just will remind people, we are a US-focused shop. We don't do much in internationals. We really never have. And I know a lot of the investment shops talk about diversification globally. They talk about the fact that the S&P's outperformed the last 10 years and soon enough emerging markets or other developed markets will catch up. We politely disagree with them. We think the US is the best place to invest, period. We think we have the smartest people here. We certainly have the deepest and most liquid capital markets here. The rule of law, all of that just points to the innovation we have here in the US as part of one of the reasons the US and China is having this tit for tat is the US knows that we have the advanced technology and we don't want to let it go. Export that advantage to other countries like China and elsewhere. So just generally speaking, I think investors that have their money here in the US, I think you should smile and be happy. I think US CEOs are focused on the right thing, and they went from a growth at all costs to a profitability forward-looking metric, and I think that's the right thing to do. So just in general, I will say that. The other thing I will say in general is there's a couple of areas that really have never slowed down, but prices got cheaper. And you mentioned a couple of them. One of them is cybersecurity. As everything goes more digital, whether it's consumers using their cell phone or getting on the internet at home, or corporations going to the data center, on-premise, to the cloud, all of those things are data related. And one of the things that you have to do is you have to keep the bad guys out of your network. And if you're accessing data via the cloud, you certainly have to protect those communications and that flow of data. And so cybersecurity, generally speaking, has continued to be a growth sector, but now it's growth with profitability. And coming off the fourth quarter earnings releases, firm after firm kind of repeated the exact same thing. So that's something that's durable. The stocks are cheaper. You also mentioned chips, and chips is another area that we think are very, very interesting. Used to be the chips industry was a cyclical industry prone to boost and busts. And not so much. I mean, we're using chips every place and almost everything now. So yes, we had an inventory correction coming off of COVID but it looks like chips now are going to be priced from a cyclical industry to more of a secular grower. So you could get multiple expansion there. Those are two areas that we think are attractive.

Thanks, Nolan. It's been a difficult week, but we do think there's a lot of opportunity coming out of the news flow. Anything we want to leave the viewers with as we, uh, bid them adieu for this week.

Nolan, on the action that we've had the last couple of weeks, I think there's very attractive opportunities. Let's start with bonds. Brian mentioned earlier that the 2-year rate, the short-term rate, has to collapse to below 4% and the 10-year rate has collapsed to below 4%. And we've been talking about this for a couple of months, that if you have cash at the bank and you're an investor that is either headed toward retirement or you're in retirement, you need your portfolio to kick interest income to you. This is a really exciting time, but time is of the essence. You can actually buy fixed-rate securities now and we're getting yields of 7 to 8%. The only question you need to ask is how long you want to lock those up for. You can lock them up for 2 years, 5 years. We find attractive— we like the idea of a bond ladder stretching out 15 years, in some cases more, because if we've hit the top on interest rates, these rates may not be on offer much longer. I think the other thing is this bank panic has created a lot of other opportunities as well. Even in banking has been a fairly safe place to invest. The banking system has been coming off of this. These banking shares have gone down a lot. A lot of people will be looking to bargain hunt in the banking stocks. We think there's more interesting ways to play a banking recovery, and one of them may be the bonds of these banking institutions. Yes, these lending institutions have bonds that trade. A lot of them are A-rated or very high investment-grade rating bonds. And with the price action the last couple of weeks, these bonds have come down. So now we're locking in very attractive yield, 7% in some cases, on investment-grade bonds. And if this banking system situation goes back to normal in the next 6 to 9 months, you could see capital appreciation on top of the income stream you're locking in. And then finally, with stocks, I think with all of the headline global macro Ukraine fly— uh, Russia flying into a U.S. drone, uh, the banking collapse in Europe, here in the U.S. A lot of people are kind of putting their head under the covers here. We think there's a lot to like even in stocks. A couple of our old favorites— you mentioned names earlier that we had revisited from years ago— Netflix, which is very interesting to us again, where it looked like 2 years ago the streaming competition was really getting to a boil. And now it looks like it's starting to go in reverse. A lot of these streamers see how difficult it is and they're tired of burning billions of dollars every year. So I think the competition is lessening. And no matter which way you look at it, Netflix definitely has the best content library out there. They're profitable and the forward multiple's attractive. So Netflix is a name that we're interested in again. And a final name that really is coming back as a Lazarus stock is Meta, the old Facebook. Social media is something that's definitely a addictive. They have got their head on straight, focusing on profitability instead of burning billions of dollars in this upcoming metaverse. And that has lit the stock on fire. And after the 65% drop last year, Meta's in a bull market. I think there's a lot of upside to come. So those are two names that we're very attracted to, right?

Nolan, I'm gonna hop off of Instagram and thank the viewers for being with us. Thank you, Nolan, and we'll see you again next time.

And good luck in your brackets.

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