3 reasons why the banking crisis is good for the stock market
The failures of Silicon Valley Bank and Signature Bank in March could be the biggest strain on the banking system since the 2008 financial crisis. isolated, the result of poor risk management practices. as opposed to an industry-wide systemic failure, but we still don’t know the full extent of the damage.
What we do know is how the US government reacted to the situation. Within days, the Federal Reserve set up emergency lending facilities to ensure risky financial institutions had more than enough cash to operate. The FDIC stepped in to guarantee all deposits of the two failed banks. The Fed added $300 billion to its balance sheet in a single week, reversing the last 4 months of quantitative tightening in one fell swoop.
While the idea of structural and systemic instability in the financial sector is disconcerting, there is a silver lining to this for equity investors. Since March 22, the SPDR S&P Regional Banking ETFs (NYSEARC:KRE) is 32% below its 2023 peak. Investors 1) are throwing the baby out with the bathwater or 2) believe this problem may be more widespread than we currently think. The latter could certainly turn out to be the end result, but here are three reasons for today’s bullish argument.
Liquidity drives stock prices higher
Whenever the Fed steps in to ease financial conditions, whether through lower interest rates or direct bond purchases, the extra liquidity has often resulted in gains for risky assets. 2018 and 2020 are good examples.
In 2018, the Fed was finally trying to normalize post-financial crisis monetary conditions. At the time, a recession was looming in Europe and investors feared that this risk would spill over to the United States. In the fourth quarter, the S&P500 fell about 20% from peak to peak. The Fed quickly turned dovish and markets began pricing in rate cuts rather than hikes. In April 2019, the S&P 500 was back at all-time highs.
A similar story unfolded during the Covid-19 recession. Stocks had fallen more than 30% when the Fed cut rates to 0% and the government announced a multi-trillion dollar stimulus package. In August 2020, the S&P 500 was again trading at all-time highs. In both cases, the stocks recouped all of their losses within a few months.
We could be in the early innings of a similar quantitative easing program today. If the Fed is about to add trillions of dollars to its balance sheet, as JPMorgan suggests, that could fuel a similar rally.
The government was quick to counter downside risks
In 2008, it took months for the government to react to the financial crisis. In 2023, it took a few days. As I mentioned earlier, the government stepped in to guarantee all the deposits of the two failed banks and could still do so for all the banks.
The Fed and major banks have opened up lending facilities to keep the financial system moving and cut off any potential bank runs. It sounds like a situation where the powers that be will do everything in their power to mitigate potential risks.
Bank failures are isolated
Silicon Valley Bank, which catered to tech startups and venture capitalists, and Signature Bank, which was heavily involved in the crypto space, are unique institutions in terms of customer base. These are not your typical community banks serving the general population. Moreover, the main cause of their falls was poor risk management practices.
So far, we’ve seen little indication that this is a widespread risk (although we may still see a few more cases occurring). It is entirely possible that we have already seen the worst. If so, a 30% drop in regional bank stocks could possibly be seen as an overreaction.
The strategies I use all involve quantitative processes that take emotion out of the question. If investors look beyond the headlines, they may find opportunities in stocks right now.
As of the date of publication, Michael Gayed did not hold (either directly or indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com Publication guidelines.