By Craig McAvinue – 4 April, 2023
“Know what you own and know why you own it.”
With the close of the month of March and the first quarter, we see generally positive results across the markets. March saw losses on the London and Shanghai exchanges, but all the markets we track here are up year to date.
Data table is from Google Finance
Given the banking issues in March, it’s not surprising to see that the USD lost ground against most other major currencies.
Data table is from Google Finance
Financial headlines throughout March focused on large and well recognised banks on both sides of the pond receiving government help in order to avoid major disruptions.
Two of the banks in question were Silicon Valley Bank (”SVB”) and Credit Suisse. While some in the media would have you believe that we’re seeing a rerun of 2008, with talk of bank runs and financial collapse, the real picture can only be seen by looking at each of these two institutions in isolation, not broadly associating them with the wider world of finance.
An irony about SVB’s collapse in comparison to what happened in 2008 is that the bank had invested in long term Treasury Bonds, which are thought to be as safe as can be. Awash with capital from startups and tech companies who flourished during the pandemic, long dated bonds seemed a safe and smart bet for SVB in light of the low interest rates since the recent financial crisis. This is in complete contrast to 2008 where the investments being made by banks were very high risk.
However with the aggressive interest rate rises dished out by the Federal Reserve, these long dated bonds lost much of their value. When the tech sector started to take a hit last year, those start ups slowed their investments into SVB, creating significant cash flow problems. This was the cause of the bailout.
Over in Europe, Credit Suisse was also in the headlines. A name and a sector that is associated with being steady and even stoic was discovered to have a very high risk approach. The Swiss banking sector and Switzerland in general has always been enigmatic, not particularly transparent and, to a certain extent, a law unto itself. The correlation between Credit Suisse and Union Bank of Switzerland (UBS) and the Swiss National Bank meant that, when it came to the crunch, a big name was never going to be allowed to fail. Sure enough, a deal involving UBS was fashioned and today we see business as usual, albeit with some collateral damage for those Credit Suisse shareholders.
Although we need to be skeptical of the way situations above are reported, one reality of the banking system is that only some 10% of financial transactions can be backed by cash. It’s at this point that the Bitcoin brigade will point to its stellar performance, up a whopping 71% so far this year. The fear of a cash crisis, coupled with the huge falls crypto experienced since its peak at the end of 2021, undoubtedly encouraged this buying spree. This volatility in the crypto sector again illustrates that only those with the right high risk appetite should be buying here.
Financial services as a sector is one of the most complex. Regular readers will know that it is not a sector I favor, mostly because of these complexities. Some will also note the quote at the top of this report as being one I have used in the past, quite frankly because it is one of the most fundamental principles of investing: you need to understand what you own.
Sectors play an important role in creating a portfolio that will succeed in the longer term. As illustrated below, so far this year areas like Communications and Technology are up over 20%, while other sectors like Financials and Energy are 25% worse off.
Understanding the areas you invest in and how they impact your own portfolio are key to success in the long term. Despite what seemed like a month when the financial world was heading for meltdown, the S&P 500 did rather well, up 3.2%.
So why is this?
A lot has to do with the size of some of the companies in the S&P. Unlike when it was first established in 1957, when you could buy a simple low cost tracker of the index that gave you evenly distributed exposure to all sectors of the market, these days you have far more exposure to individual shares.
To illustrate this, during the month of March, around half of the gains we saw in the S&P came from just two companies, Apple (+11.4%) and Microsoft (+15.6%). This was why the “market” was up despite the aforementioned financial issues, a weakening dollar and the haywire that went on with government bonds.
To add another layer of perspective, the Credit Suisse buyout was for US$3.2 billion. With Apple and Microsoft’s combined value of around US$4.5 trillion, those two companies alone are worth some 1,400 Credit Suisse’s!
This also calls into question a passive approach to investing, which is widely advocated by those who see cost as key when choosing where to buy. It’s important to understand whether this passive approach does indeed offer the right risk versus reward. Again it’s all about understanding what you own … and of course it helps if you know why you own it.
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