Equities were able to look past crises with a strong monthly and quarterly performance while fixed income signaled warning signs ahead.
Biggest bank collapses since the Great Financial Crises
The collapse of two U.S. regional banks in early March sparked fear about potential contagion to other regional banks and the stability of the broader banking sector. On March 10th the U.S. regulators took control of Silicon Valley Bank (SVB) following a run on the bank when panicked customers withdrew US$42 billion of deposits in a few days. Similarly, U.S regulators also closed Signature Bank of New York a few days later when depositors withdrew large sums of money. The panic quickly spread to Europe as concerns centered around Credit Suisse defaulting on its debts. Despite the Swiss National Bank’s effort to intervene by providing a CHF 50 billion lifeline, Credit Suisse was ultimately taken over by UBS on March 19th in a deal brokered by the Swiss government and regulators.
Tighter lending standards raises recession odds
The bank collapses demonstrated to the broader banking industry what poor risk management and duration mismatch could lead to. As the regulators get busy in drafting up new regulations, the more immediate fallout of the banking crisis will likely be tightening of lending standards. If tighter lending standards do materialize, it will have a tightening effect on financial conditions, not unlike the effect of rate hikes. This increases the likelihood of the economy slipping into recession later this year. The fixed income markets swiftly softened their views on the path of policy rates. Currently, markets are pricing in Fed rate cuts of 0.75% and Bank of Canada cuts of 0.50% by year end. At the beginning of March, December policy rates for both BoC and Fed were expected to be flat from current levels.
Earnings estimates cut again
Analysts continue to drop their earnings estimates for the S&P 500 companies. S&P 500 earnings are now expected to be flat for 2023, down from 10% growth last summer. Estimates for next year have been cut as well. Whether there will be more cuts in the face of a slowing economy remains to be seen. The banking sector earnings in particular will be closely watched to see how the recent turmoil is affecting balance sheet, earnings and credit growth.