SVB Crisis: The Impact on the Stock Market as Bulls are on High Alert for Fear of Systemic Risk

It's one thing for a fired-up Federal Reserve to crush bitcoin, or for moonshot web stocks to crash down to earth when rates rise. As central bank policy begins to bite into banks, investors realize they have greater problems on their hands.

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Fear of systemic danger swept markets this week, as investors who believed they'd weathered the brunt of Jerome Powell's assault on inflation saw their worst streak of losses in five months. Bank stocks, long seen to be safe havens in a rising-rate world, led the decline, marking their worst week since the Covid crash.

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While the judgment is yet out on whether SVB Financial Group's bankruptcy foreshadows widespread risk to the financial system, signals that it did were enough to frighten investors who were sitting on returns reaching 10% for 2023 only a month ago. The advance had fallen to less than 1% by the end of Friday, leaving bulls with the warped optimism that things are awful enough that Powell's Fed won't dare to increase rates much more from here.

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"This circumstance will force the Fed to proceed more gradually," said Alec Young, chief investment strategist at MAP signaling. "Everyone was concerned in the back of their thoughts that something would break — people think, 'Well, this is the item that's breaking.'"

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Last week's events shattered a key tenet of the bull argument for equities, namely that increasing interest rates were causing no harm to anyone. Consumers and huge corporations, the argument said, protected themselves from Jerome Powell's ardor by locking in loans when yields were nothing. Banks, on the other hand, have emerged as an exception to that notion, as rising rates burden lenders with paper losses on bond holdings and entice depositors away. If there are too many defects, the paper losses might swiftly become realized losses.

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For investors in general, the issue is whether investor concern about the banking sector is sufficient to spark another significant down leg in a bear market that began 14 months ago. Skittish traders are aware that the 2008 financial crisis disaster did not have its worst stretch until roughly a year into the selloff when the failure of Lehman Brothers brought the S&P 500 down 30% beginning in September of that year.

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This time around, few are calling for that level of destruction, but nothing puts bulls on higher alert than the idea of systemic risk. According to Brent Donnelly of Spectra Markets, the S&P 500's loss from 4,100 this week may be the beginning of a sharp selloff that could eventually reach 3,650 to 3,700 during the following week, a down of more than 5% from the Friday close of 3,861.59.

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"Go ahead and take a shot right now. "Investors in the SPDR S&P Regional Banking ETF can't simply sit there and mull things over; you just get out," Donnelly said. If you are long KRE, you should just exit and then decide what to do.

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A capital outflow from the tech firms that Silicon Valley Bank had served for 40 years caused it to collapse, making it the largest US bank to fail in more than a decade. Days after cryptocurrency-friendly Silvergate Capital Corp. said it would liquidate and wind down operations, the company collapsed.

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The S&P 500 saw its worst week since September as a result of the accompanying decline in bank stocks and contagion worries, which sent the index down 4.5%. Although expectations that the Fed could be approaching the conclusion of its tightening cycle fuelled a strong surge at the start of 2023, the index's year-to-date gain is all but gone.

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The chance that the central bank could shortly halt rate rises and decrease rates by year's end is once again being priced in by markets. This caused the two-year Treasury to yield to have its worst two-day decline since 2008 after earlier in the week it crossed the 5% threshold for the first time since 2007.

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Yet this time, stock bulls find little solace in that recalibration.

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They keep moving until something breaks, particularly in an inflationary environment, according to Michael Collins, senior portfolio manager at PGIM Fixed Income, on Friday. I contend that the chance of anything breaking is now somewhat greater than the chance of uncontrolled inflation.

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SVB's struggles served as a warning that banks may find it difficult to create profits even in a rising rate environment, even if no systemic danger materializes. Given that experts predict the group will have the second-highest profit growth among S&P 500 industries this year, it might cause problems for everyone.

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While higher interest rates are normally assumed to boost interest income, the problem is compounded in 2023 by a sharply inverted yield curve, which lowers returns on longer-dated assets against short-term obligations. Keeping deposits is difficult when money market rates are up to 50% higher than savings account interest rates. If deposits vanish, banks may be obliged to record what were previously simply paper losses on mortgage bonds and Government assets they must sell.

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Due to its service to the type of venture capital-backed businesses and startups experiencing cash flow problems as the Fed tightens the screws, SVB ultimately became the face of that issue.

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Ellen Hazen, chief market strategist, and portfolio manager at F.L. stated, "This is just another example of things breaking in an economy that has become quite acclimated to low-interest rates for a decade and a half. Investment management by Putnam. "Things are going to break because there were entire business models constructed on free money," said the economist. "When those rates start rising, both nominal and real, which is what has been occurring for the last year."

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