A lot is now being written about the collapse of SIVB. The political left, for example, is blaming Trump, the political right the diverse composition of the board of directors. The latter, I think, is just crazy; the former a bit disingenuous. Cathie Wood of ARK has also chimed in with the, I think, totally bizarre opinion that the Fed is the root cause of the SIVB affair, having pushed short-term interest rates far too high.

From my vantage point, it looks as if SIVB made a huge all-or-nothing bet that interest rates would remain at 2021 levels. It did this in two ways: by using customer deposits to buy enormous amounts of long-term Treasuries, and by choosing not to hedge against the possibility of higher rates. Dynamic hedging, a strategy that has been around for close to forty years, comes to mind as a more bank-like way to proceed.

What strikes me as equally odd, if press reports are correct, that a company like ROKU would place close to half a billion dollars on deposit with SIVB without having taken a glance at the SIVB annual report–as did a bunch of companies in the Peter Thiele orbit.

SIVB clearly saw the crisis coming as withdrawals mounted. One of the first actions we on the outside can see is the then-CEO selling a bunch of his stock. Then came plans for a private placement, to be followed by a public offering of preferred stock the following day, aimed at raising a total of $2.5 billion. The private placement fell through (my theory: SIBC put off the placement, on the idea that a successful offering would mean the placement could be made at a better price).

In a JP Morgan note I read, the author makes the point that depositors took the enormous risk of putting their money with SIVB but were only compensated with a paltry extra 60 basis points in yield.

The financial press coverage has, by invoking memories of 2007-09, been both uninformed and at least borderline irresponsible.

The only party that comes out looking good in this mess is the Federal government, whose quick and decisive action has hopefully nipped a possible panic in the bud.

not a fan, except for sometimes

Yes, I have owned bank stocks. In fact, I have a small position in Bank of America (BAC) at the moment, on the idea that in a time of rising interest rates banks increase their lending rates much faster than they raise the rates they pay to depositors. So the spread they make widens. This is conventional wisdom without not much more to it.

My biggest issue with bank stocks is that they are opaque, even at the best of times. What they do (apart from their role in helping set overall central government monetary policy) is simple: they take in deposits (i.e., borrow) from individual and corporate customers, and then lend these funds, typically for much longer periods of time, and at higher rates of interest than their deposits, to individuals and businesses. Try to go much deeper–who are the customer?, what are the biggest loans? what are the riskiest/safest?, and there’s virtually no relevant information publicly available.

As a result, professional investors tend to look at bank stocks in an old-fashioned way, that is, based on the company’s per share “book,” or shareholders’ equity, value. But that’s pretty much all a non-specialist in bank stocks can do is.

The idea is this: shareholders’ equity is the accumulated profits of the firm that can be used for future investment. A stock that trades at 1x book is expected to product average profits. One that trades at 2x book is expected to make twice what the average bank can make with its capital. …and so on. At one time, for instance, Goldman Sachs was the star of the brokerage industry and traded at 3x book. As the GS star has waned, that multiple has contracted to 1x.

SIVB

First, remember that while I have been a professional investor for over a quarter-century, I’m not a bank expert. Having said that,

this is a really weird situation. How so?

–in late February, just days before the stock imploded, the company filed its 10K for the 2022 year. Its accounting firm, KPMG, issued the following unqualified opinion of the financial statements contained in it.

“We have audited the accompanying consolidated balance sheets of SVB Financial Group and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.”

There’s more–commenting, as I read it, on the difficulty of assessing the quality of an idiosyncratic loan portfolio, but nothing serious enough to merit qualifying the audit opinion.

—-looking at the financials,

assets

–cash and cash-like securities are $40 billion

–long-term securities, carried at cost, are $120 billion, for a total of $160 billion, or about $200 a share.

liabilities + equity

–deposits are $173 billion, of which $92 billion is non-interest-bearing

–common shareholders’ equity is $16 billion.

The key things to notice here are that the long-term securities (predominantly Treasuries, I think) are not marked to market, and that if marking them to market today resulted in a loss of as little as 15%, shareholders’ equity would be completely wiped out.

—-$200/share in net worth?

Given that large inflows came into SIVB in 2021, when interest rates were exceptionally low, and $80 million+ went into Treasuries that year, it’s difficult to fathom how investors could have overlooked the possibility that that $200 a share in net worth might not be a solid number.

If for most of 2021, as was the case, one would have to reach for a 7-year Treasury to get a yield of 1% and a 10-year to get a yield of 1.5%, the reported interest income for 2022 suggests something like a 50/50 split between the two. If so, this implies a loss of market value of these bonds of around 20% if they were sold today rather than held to maturity.

This isn’t rocket science. It’s just drawing inferences from publicly available government filings. Yes, my numbers may not be 100% accurate, but they suggest that the company could easily have been flirting with negative net worth for some time. If so, management was running a huge risk by not raising capital once it became obvious the Fed was going to boost the Fed interest rates very substantially. And it left itself open to the run on the bank that developed as depositors (belatedly) worked this out.

Until relatively recently, I haven’t been a big fan of Paul Krugman. Over the past ..oh, year or so, though, I’ve found his opinion pieces in the NYT very interesting.

The other day he wrote one about inflation, in which he said (or I heard) that the economics profession is at a loss right now, with nothing much meaningful to say about the current inflation. How so? He traces this inability back to a basic assumption of modern macroeconomics: that supply/demand imbalances in goods and services will rectify themselves in short order. Therefore, they don’t need to be taken into consideration when analyzing or setting general economic policy.

That might have been good enough a half-century ago, when the world was dominated by a US economy whose plant and equipment hadn’t been destroyed in WWII, when supply chain tools were in their infancy and OPEC hadn’t begun to flex its muscles. But it isn’t any more.

It seems to me that we’re now in a world where microeconomists, who study competition among firms and industries, and whom the academic world has always regarded as a bunch of career minor leaguers, have now become stars of the show.

The way I see it, the current inflation in the US is the result of three factors:

–the application of what has turned out to be too much fiscal and monetary stimulus to the domestic economy in countering the negative effects of the pandemic

–the NATO decision to boycott Russian oil and gas,–and, maybe more important in the long run, the denial of US oilfield drilling and maintenance services–after that country’s invasion of Ukraine, and

–the recasting of the current world-spanning industrial supply chain as a result of political changes in China and the US.

It seems to me that:

–fixing the first issue is well underway

–in a political sense, the much bigger boycott issue with Russia is natural gas, which is 4x or so as important as oil as a source of foreign exchange. My guess is that because boycotts are inevitably leaky, the bigger oil issue is output reduction if/as local petroleum engineers are unable to perform routine maintenance. The natural gas issue isn’t one of alternate supply–there’s plenty of that, and of technology to get gas into local pipeline networks. It’s all about capacity of LNG ships to get output to Europe and terminals to receive and regasify it. For what it’s worth, Germany is apparently now worried about overcapacity

–this is the tricky one. And it’s overwhelmingly a microeconomic issue. It’s mostly about relocating semiconductor capacity away from Taiwan and relocating simple manufacturing/assembly operations away from China. But it’s also about the fixing the long-standing inefficiency of Los Angeles-area ports, educating inept American auto manufacturers about how to order semiconductor parts, how many new plants need to be built–of what type and size, and where… My guess–and I have to constantly remind myself that I’m usually too early/optimistic–is that we’re past the worst of the supply disruptions in most everything. I don’t think higher short-term interest rates will either help or hurt too much. Ironically, a higher cost of capital may retard the readjustment of supply chains and manufacturing capacity a bit, however.

Tomorrow: how my portfolio is dealing with this

…for the first time in months. My wife and I spent a few days in Arizona for the beginning of spring training and then in LA visiting two of our children. My impressions:

–tons of people are out to see baseball. From the dearth of the usual souvenir items, it looks like the teams weren’t expecting this large an influx

–the pitch clock is a big hit

–one of our favorite restaurants in Scottsdale has imposed a $20/person fee for reservation no-shows. Despite this, maybe 20% of the tables were empty when we got there. Inability to get staff. Prices were high everywhere except US Eggs. Portions seemed smaller (a relief for me), too.

–hotel rates were double their pre-pandemic level. The Hilton we stayed in had housekeeping services on request only. What makes this potentially interesting to me–we didn’t use the (free) service while we were there–is that hotels have a high degree of operating leverage. The rule of thumb I use is that cash breakeven is at 50% occupancy and financial reporting breakeven is at 60%. At 70%, the hotel is coining money. My back-of-the-envelope guess is that the reduction/elimination of housekeeping services for people staying more than one night could have the same positive effect on earnings as an extra 5 percentage points in occupancy. My experience is not by itself a reason to buy a hotel stock, but a possible source of positive earnings surprise. I have a small position in HLT. I’m not sure I’d recommend the stock to anyone else, but I’d be interested in any comments you might have about your own lodging experiences.

In September it will be 45 (!!!) years since, being unable to get a college teaching job I would accept–or, arguably, any job at all, I stumbled into the US stock market. I mention this both because I find it hard to believe and, more importantly, to underline that I learned the trade in a radically different time. There were tons of securities analysts, spread over numerous brokerage and professional investment shops, no trading bots and a vibrant, sophisticated financial press.

Today, the analyst community is much smaller and the only really good reporting comes from the Nihon Keisei Shimbun family (which includes the Financial Times and the Economist). Trading bots rule short-term trading. But you and I have almost infinitely quicker access to company SEC filings through the SEC edgar site.

All in all, the chance of success for an individual willing to take a six/twelve month view and read SEC filings intelligently seem to me to be much higher than when I started out.

Trading bots, however, and whatever other relatively clueless short-term trading there may be both make the daily or weekly signals from changing stock prices much harder, for me at least, to read.

I’m writing all this as a warning, to you and to myself, not to bet the farm on what I’m now thinking.

That’s that the US stock market appears to me to be bottoming. What makes me say this?

–bear markets tend to last between 12 and 18 months. This one began on 12/1/21. We’re now in month 16 past the peak.

–from the top to recent lows, NASDAQ lost a third of its value, the S&P 500 a quarter. Yes, that’s not as bad as the meltdown of 2007-09, but the global financial system hasn’t collapsed under the weight of massive bank fraud (and the unwillingness of Congress to either come to the rescue )a Republican refusal) or punish the fraudsters (both parties)) this time around. In fact the rescue package has probably been too big. So arguably we’ve had enough pain. even for a worse-than-garden-variety recession.

–in bear markets, investors react strongly negatively to bad news and tune out good. Produce good numbers/stellar guidance and unchanged is the best you can hope for. Produce ugly numbers/lackluster guidance and the stock plunges.

At some point, however, and not necessarily for all stocks, valuations will have fallen far enough that investors begin to weigh strong long-term earnings potential against the blemished here-and-now. TGT and WMT, for example, both reported poor 4Q earnings and weak 2023 guidance last month. Both were flattish on the news and gradually rallied rather than declined.

This reaction may be a formal calculation of the assumed net present value of future earnings, or an evaluation of the worth of the brand names, or even just the informal read that the worst of the negative surprises are behind us and the stock is probably not going to get much cheaper–or all of this. The main thing is that the stocks don’t show a typical bear market-style collapse.

My read is that the market is doing this, as well as something a little more subtle. It’s separating winners from losers, based on its analysis of a company/sector’s chances to rebound as the economy recovers. In other words, the companies/sectors with longer-term issues, which are not going down solely because of current economic conditions (think: big-city office buildings, the FAANGs) aren’t showing the same signs of life as presumed next-cycle winners are.