Counting Your Chickens Before They Hatch | The Daily Peel | 3/15/23

Mar 15, 2023 | Peel #419

Silver banana goes to...

Market Snapshot

Happy Wednesday, apes.

Go ahead and just set your degree on fire now. Turns out bank runs are actually pretty sweet, at least, judging by the market’s reaction yesterday. Then again, I guess Joe, JPow, and Janet throwing billions at the problem could help.

While the dust sure ain’t settled, markets are pricing equities like the SVB collapse is already done and over with. Indices ripped yesterday, mostly peaking around 11:30 am ET but ending the day with another strong push hire.

Tuesday’s CPI report def didn’t hurt, but if you told me on Friday that markets would be up ~2% on Tuesday, I’d probably question who raised you.

To use a trading term, treasuries had a volatile-ass day that ended with the 2- and 10-year yields rising slightly, with the 2-year poetically ending the session at a high of 4.20%.

Let’s get into it.

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Banana Bits

• They say boys will be boys, but I guess adversaries will be adversaries too, as two Russian fighter jets shot down a U.S. MQ-9 surveillance drone over the black sea in what Pentagon officials have called a “juvenile” act and one that was likely accidental
• Uncle Joey B has really pissed off his environmental friends this week after approving ConocoPhillips’ $8bn drilling project
• These are the kind of diplomatic actions the whole world needs. Chick-fil-a has begun its project of chicken diplomacy as it looks to spread that spicy goodness to Europe and Asia. If you’re reading this from one of those continents: get excited
• Meta acts efficiently to double down on enhancing efficiency as the firm cuts 10,000 current and 5,000 future jobs. Rumors say that JPow was elated at the news

Macro Monkey Says

6% Is the New 2%?

What a blessed day.

No, not because my portfolio was actually green for once (forgot the numbers could turn that color) or even because it was the 20th day of lent. Yesterday was blessed because actual macro data dropped, meaning we can talk about something besides SVB for once!

CPI day has been like a monthly Super Bowl for market watchers ever since that terrifying 0.6% monthly reading in March of last year. But now, it looks like inflation truly has spread everywhere, even to inflation itself, as the 6% annualized print we saw yesterday was welcomed with open arms like a 2% print in any other year.

So, we’re ready to declare 6% as the new 2%. Should we just call off the rate hikes now, or…?

Well, according to the ever-so-wise Mr. Market, there is about a 21% chance that actually happens. We still sit at 79% odds of a 25 bps hike, but we’ll take that all day over last week’s anticipations for a 50 bps yank.

It’s days like yesterday where the degree of uncertainty is as palpable as your coffee actively staining your teeth. Don’t believe me? Buckle up.

• One week ago yesterday, Powell teased the possibility of going back to 50 or even 75 bps rate hikes
• Market-implied odds of a 50 bps hike fell from 70% to 0% in 4-business days
• The second and third largest banking failures in U.S. history barely moved index levels and rate hike expectations from ~2-weeks ago, yet sent the VIX on a ride
• Banks, not meme stonks, like First Republic, lost >80% of their value and then subsequently gained more than 100%, all within a less than 5-day span
• 2-year yields are running around like a chicken with their head ripped off and thrown into an incinerator

Mr. Market’s feeling a little quirky, to say the least.

But, what may have played a role in calming nerves was yesterday’s in-line inflation reading, as measured by the CPI, of 6%. Again, in literally any other year ever, this would’ve been a “sell the news” event like no other. But 2023 is built different.

On a monthly basis, inflation gained 0.4%, also right in line with estimates. That slowdown from January comes largely thanks to declines in energy commodity prices, particularly in fuel oil, falling 7.9% in just one month. Food costs fell, too, with FinTwit’s new favorite food, eggs, cracking by 6.7%.

Now, housing, on the other hand, moved in the opposite direction. Shelter costs surged in February, rising 0.8% as a group since January and 8.1% since 2022. Keep in mind this line item makes up nearly 33% of the consumer inflation index’s value and contributed to over 60% of February’s price gains.

The good news is housing prices run on a major lag, meaning costs are likely (hopefully, fingers crossed) experiencing more of a downtrend that we just haven’t seen yet. Still, it’s those services costs, with an emphasis on shelter-related services, that JPow is trying to tear down, much like Reagan and Gorbachev did to that damn wall. If they’re going solely off this CPI print as the measure for housing/service/housing-service inflation, then he and the gang still have a whole lotta work to do.

I mean, we already ripped two bank failures this month; why not a few more?? Keep the rate hikes coming; obviously, nothing bad happened after the first 475 bps, all of which occurred in less than 12 months, while the Fed chair claims to be “aware” of monetary policy’s long and variable lag. What could possibly go wrong?!

What's Ripe

First Republic ($FRC) ↑ 26.98% ↑

• And here, we see Mr. Market’s schizophrenia on full display. As pointed out above, the stock that collapsed over 80% one day has now more than doubled in value since about 10:30 am ET on Monday. Welcome to U.S. financial markets.
• Honestly, it was the best news investors could get. Thanks to added financing from JP Morgan this weekend, First Republic could finally say, “woohoo! We aren’t 100% definitely going out of business anymore, yay!!!”
• Needless to point out, traders were pumped. Still, despite the gains seen on Tuesday, analysts covering regional banks at other less-regional banks like Raymond James say to stay far away, citing still garbage deposit balances as the driver.

Digital Currencies ($BTC, $ETH)

• There are basically two lenses through which to view this, but regardless of which one you pick, the value of digital currencies like BTC has surged in recent days…
• Lens 1: The Crypto-Bro View: Prices of BTC and other digital assets are surging due to the sudden and drastic decline in confidence in the real banking sector. As a result, investors poured cash into “safe money” assets like BTC (lol).
• Lens 2: The Non-Idiot View: Prices of BTC and other digital assets are surging as the SVB collapse and the in-line CPI print have smacked the market’s view of the next rate hike lower. Lower hikes = more liquidity, and by now, we can all agree that the price of BTC and its friends love that liquidity.
• Is it “safe money,” an example of “liquidity rules all,” or some combination of both? You decide.

What's Rotten

AMC Entertainment ($AMC) ↓ 15.02% ↓

• If you still hold shares in this shitco, do me a big favor. Stop reading this, walk into your boss’s office, and quit your job. I heard the local middle school is looking for more third graders.
• As if we even need to explain why, AMC shares tumbled over 15% on Tuesday as the morons that own this company approved plans to sell more stock and dilute the sh*t out of themselves. Maybe these guys truly are the real apes.
• Honestly, both of our time would be better served trying to explain why this thing is still operational, but we’d need a lot more characters to do that. Good luck, shareholders!

United Airlines ($UAL) ↓ 5.37% ↓

• While the rest of the market took flight, airline stocks either crash-landed or just remained on the runway in yesterday’s session.
• United is the clear culprit here, killing the party for themselves and everyone else involved. The company came out and spilled the beans, citing lower demand and elevated costs while projecting a wider-than-expected loss for its fiscal first quarter.
• C’mon, guys, that’s like the one thing investors want to hear least. But hey, I guess at least they’re doing better than the room-temperature IQs running regional banks these days.

Data Peel

Chart 1. One-month percent change in CPI for All Urban Consumers (CPI-U), seasonally adjusted, Feb. 2022 - Feb. 2023

Chart 2. 12-month percent change in CPI for All Urban Consumers (CPI-U), not seasonally adjusted, Feb. 2022 - Feb. 2023

Source

Thought Banana

It Happened, But…What Happened?

SVB – aka “Hipster Soy Capital,” as a very loving and apparently coming-for-my-job ape coined on WSO late last week – was the largest house of cards in banking since those far larger houses of cards were saved Benny B back in 2008.

So naturally, the question becomes, what the hell happened? I don’t have to tell you apes that there are quite literally thousands of explanations meandering around the ol’ world wide web as we speak, but let’s do it better.

First, it was Lebron, D-Wade, and Bosch. Then, it was Steph, Klay, and Draymond. This time, it was rapid growth, poor management, and daddy JPow’s rate hikes.

Rapid Growth

As we touched on earlier this week, Silicon Valley Bank’s growth was explosive. Licking the boots of every startup on the planet during a boom time for loose credit and looser business morals will do that to you, so this alone can’t be too surprising.

An exploding deposit base actually creates a big problem for a bank. All of a sudden, the bank has all this cheap financing sitting as a liability on its balance sheet. Naturally, we want to turn those liabilities into assets.

So, when banks get deposits, they tend to invest those. In the United States, FDIC chartered banks must maintain at least 8% of their deposit base as liquid cash, available in an instant. The other 92% can be invested in an extremely tight, strict set of virtually riskless securities like treasuries, MBSs, and ABSs, to name a few.

Poor Management

And that’s where poor management comes in.

Yields were lower than Eeyore’s dopamine levels for most of the past decade, especially the latter half, right when all these deposits flooded in. SVB took those deposits and, wanting to earn a higher spread on the yield it earned vs. what it paid out to customers on deposits, searched for the highest yields it could.

Given the (very) limited investment universe available to Hipster Soy Cap, there was really only one way to eat up the yield they were hoping for: extending the maturity of their investments.

That’s all fine and dandy until you realize one basic fact taught in Fixed Income 101: the higher the duration of your assets (aka the longer the maturities), the more responsive those asset prices will be to moves in base rates.

Since JPow has been on a rate hike tirade characterized by more determination than George Washington crossing the Delaware, the value of those long-dated treasuries, MBS, and ABS on SVB’s balance sheet got f*cked.

Daddy JPow’s Rate Hikes

Remember those 475 bps of rate hiking we mentioned earlier? Yeah, that was the nail in the idiotically built coffin of SVB’s balance sheet.

Now, the problem comes from a subtle difference in the accounting treatment of certain assets in which banks invest their deposits. They fall into two buckets: Available-For-Sale (AFS) and Hold-to-Maturity (HTM).

AFS assets are just that - the bank’s CFO and other financial managers can choose to sell those assets into the market whenever they please. As such, these assets must always remain marked at their current market price on the bank’s balance sheet (aka “marked-to-market” assets.

HTM, on the other hand, does not need to mark-to-market as the bank has the legal obligation to hold the assets to maturity. That means that they’ll get their par value back when (and if) that maturity date comes.

So, Powell’s rate hikes eviscerated the value of these assets, particularly as high-duration assets are more exposed to rate hikes. Moreover, the relationship is not linear, but we don’t have time to get into convexity today.

What Happened

So, because those HTM assets did not have to be marked-to-market, few investors managed to see what was brewing. SVB realized a $1.8bn loss on its AFS assets, causing it to look to raise funds and triggering the bank run.

Now, unrealized losses on the HTMs and other far-too-nerdy assets on the firm’s balance sheet were the real problem. The dollar value of these losses exceeded the amount of equity in the bank held by investors, meaning the entire company is worthless. If they could’ve held those assets to maturity, who knows what could’ve happened. The game was over as soon as the bank run was underway.

We can blame regulators, we can blame JPow, but the idiots running this bank are clearly the most at fault. A junior with a C+ average getting a finance degree could’ve spotted this duration mismatch had they had the requisite data. Too bad a CFO making nearly $4mn/yr couldn’t.

The big question: How will regulations on the assets banks be allowed to invest deposits in change in the aftermath? Will any SVB executive be held liable? Are there any other banks teetering on the brink?

Banana Brain Teaser

Yesterday — People buy me to eat, but never eat me. What am I?

Plates and cutlery.

Today — It’s 150 bananas off the Venture Capital Course for the first 3 correct respondents. LFG!

What type of house weighs the least?

Shoot us your guesses at [email protected] with the subject line “Banana Brain Teaser” or simply click here to reply!

Wise Investor Says

“Risk comes from not knowing what you’re doing.” — Warren Buffett

Happy Investing,

Patrick & The Daily Peel Team

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