Quarterly Newsletter 03/31/2023
You may find this hard to believe, but every quarter I struggle to find a topic I think will spark your interest. This quarter, a lot went on, so I had a lot to choose from. In a week my twins will turn 13. We will officially have teenagers in the house. With this increase in age comes a thirst for knowledge and an interest in what dad does for a living. Just last week, we were watching CNBC and Cassidy asked, what’s going on with Silicon Valley Bank (SVB) and why did it fail? Did people lose money? Being a proud dad, I felt like this was my opportunity to enlighten my daughter with some knowledge. These opportunities rarely happen so I felt like I had to jump on it while I could. It just so happens I also got this same question quite a bit from clients, so I thought I would explain it here in this letter exactly how I explained it to her.
You see banks are the oil of our economy. They take cash in, and they lend cash out. I explained to Cassidy that when you put your cash in a bank, the bank doesn’t just hold onto it in the safe and wait for you to ask for it back. They take that money and invest it by loaning it out to people, businesses, or the government. A bank is required to only keep 10% of the cash it takes in on hand for redemptions and the rest can be loaned out. SVB had a niche. It primarily had banking relationships with venture capitalists and start-up companies. During the pandemic, when the economy was roaring, and the government was pumping tons of money into the system. These venture capitalists and startup companies banked a lot of this money with SVB. SVB took this money and invested it in a variety of things including treasury notes (a treasury note is a loan to the US government that matures anywhere from 2 to 10 years). Normally, there would be nothing wrong with this strategy because the treasury bills are backed by the full faith and credit of the United States of America and the bank is guaranteed to get its money back. Where the strategy blew up was when you lend the government money that will not be returned for 1 to 10 years, and you have depositors who need their money immediately, you have yourself a liquidity problem or what the street likes to call a “liquidity mismatch”. When one person pulls all their money out of the bank, there usually is no problem because as I mentioned before, the bank has 10% of deposits on hand. When all depositors decide to pull their money at the same time, the bank is forced to sell investments, potentially at substantial losses, and then there is not enough cash to pay everyone back. When this happens, the bank fails and the government has to step in.
So, why did I explain this all to you? The government, through the Federal Depository Institution Company (FDIC), insures depositors up to $250,000 per depositor, per insured bank, for each account category. The FDIC provides separate coverage for deposits held in different account categories. If you are lucky enough to have more than $250,000 in a bank, congratulations, but you now have an uninsured deposit at the bank. If you are in this situation, I suggest we talk so we can find alternative investments that can achieve your goals while still being protected.
You may or may not know this, but your brokerage investment accounts have insurance as well. This insurance is called Securities Investor Protection Corporation (SIPC). SIPC protects against the loss of cash and securities – such as stocks and bonds – held by a customer at a financially-troubled SIPC-member brokerage firm. The limit of SIPC protection is $500,000, which includes a $250,000 limit for cash. Most customers of failed brokerage firms are protected when assets are missing from customer accounts. In addition to SIPC protection, Pershing provides coverage in excess of SIPC limits from certain underwriters in Lloyd’s insurance market and other commercial insurers. The excess of SIPC coverage provides for an aggregate loss limit of $1 billion for eligible securities over all client accounts. A per-client loss limit of $1.9 million for cash awaiting reinvestment, within the aggregate loss limit of $1 billion. SIPC and the excess of SIPC coverage, do not protect against loss due to market fluctuation. An excess of SIPC claim would only arise if Pershing failed financially and client assets for covered accounts—as defined by SIPC—cannot be located due to theft, misplacement, destruction, burglary, robbery, embezzlement, abstraction, failure to obtain or maintain possession or control of client securities, or to maintain the special reserve bank account required by applicable rules*.
Now I know you all would like me to pull out my cloudy crystal ball and give you a market prediction, so here it goes. Before I do, I would like you to refer back to my 3rd quarter 2022 letter when I luckily predicted we would “trudge around the bottom here for another 6 months or so before we bottom in March and then start another market uptrend.”
We have a push and pull on the markets right now. The employment picture is still looking good, but inflation keeps rearing its ugly head up in certain areas, which motivates the Federal Reserve (Fed) to continue to raise interest rates. That’s not good for the markets in the short term. The more the Fed raises rates and restricts money supply, the more pressure there will be on company valuations (lower stock prices). The good thing is, I believe we are near the end of this interest rate raise cycle. The market is forward looking, so my cloudy crystal ball says we will be volatile through the second quarter while the Fed finishes raising rates, then start a nice uptrend for the remainder of the year.
Remember to keep the long term investment time horizon in mind when investing.
Thank you for reading. Please reach out to us if you’d like to discuss these topics in more detail or if you’d like to review your specific financial situation.