The last two weeks have been about as volatile and fear-driven as we’ve seen since March 2020.  While these crises always seem existential at the time, the reality is that we get these periods of high stress just about every year, and the reasons are always different.  Just last year, the Russian/Ukraine war and rampant inflation caused a brutal bear market in both stocks and bonds.  Even though that war is still raging, it is no longer the predominant headline of fear.  The current panic occurred when venture capitalist funds told their portfolio companies to pull their money out of Silicon Valley Bank.  SVB was a terribly run institution that didn’t even have a risk manager.  The bank grew its deposit base super aggressively giving sweetheart loan deals, and then moronically invested those deposits into long-term bonds at ultra-low rates without hedging.  These were the same bonds and risks we’ve been warning about for years!

As SVB blew up, the panic spread to other banks that also had a high percentage of uninsured deposits.  This led to the downfall of Signature Bank and its crypto exposure, and also has put major pressure on First Republic Bank and PacWest.  These last two are pretty solid banks, which shouldn’t fail in a normal environment, but bank runs are very far from a normal environment.  Other banks and government officials are trying to work together to craft solutions, but it is always quite complicated.  The Treasury Secretary and Fed Chairmen have given mixed signals.  They guaranteed deposits on the banks that failed and said they would do the same on other banks, but then Yellen seemed to backtrack yesterday saying she had no plans to guarantee deposits.  Then just today, she reversed and implied again that she would back deposits.  The idea is, there seems to be an implied guarantee, but not an official guarantee.  It’s yet to be seen if that is enough to stem the panic, but government officials across the globe seem committed to resolving the situation before it spreads too far.  The extreme levels of fear have caused investors to sell banks, insurance companies, real estate stocks etc., irrespective of fundamentals.  While it is not fun going through these periods, they also create opportunity.  I don’t believe we are seeing any material permanent losses of capital given our positions, and I do believe we should be able to take advantage of this selloff with some attractive buying opportunities.

One thing that I’ve learned in my 20 years working in the investment industry is that fear sells.  If I wrote a doom and gloom newsletter, I’d likely have 10 times the subscribers.  Fear sells, which is why the news stations tend of focus on it, whether it is the next virus, or catastrophe.  In investing, patience and discipline is the key.  The last thing you want to do is react to headlines.  Investing is very much like flying.  You 100% know that you are going to endure periods of turbulence.  If you jump out of the plane when the shaking starts, the results will not be good.  The same goes with investing.  Our strategy is to take advantage of the excessive pessimism or optimism that Mr. Market has at any given time.

I think the final result is likely to be some sort of increase of FDIC insurance limits or a total guarantee.  It is in nobody’s best interests for depositors to be hurt.  The banks we own are quite strong and are actually taking market share as the weaker banks struggle.  That isn’t reflected in share prices, but ultimately it should show up.  We have added a lot of tech in the selloff last year when many were panicking out of the sector.  Now during the current panic, tech is holding up quite well.  These things ebb and flow, but the key is keeping that discipline knowing that ultimately the value of the stocks should converge with the underlying value of the businesses.  On that front, I’m very confident our investments are gaining in intrinsic value irrespective of the current turmoil.  For instance, Citigroup and Bank of America should see fantastic trading results from all the volatility and big moves in financial markets.

Just as markets turned negatively almost instantaneously, they can also turn positively just as quickly, and it will almost certainly be when everyone is saying things are just going to collapse.  This isn’t a crisis led by defaults, but instead it is a crisis of fear with irrational bank runs.  The banks are actually generating extremely robust profits bolstered by higher rates.  Sure, existing bonds and loans might have declined in value a bit from higher rates, but they will ultimately mature at par, and the banks we own are in a great position to pick up deposits amidst the chaos. The only real pressure spot comes when there is that bank run we keep discussing, which wouldn’t happen with the higher insurance levels.

In summary, we are watching things very closely.  We have never owned Silicon, Signature, First Republic or PacWest and we aren’t buying them.  The easiest solution would be increasing FDIC insurance levels up to a million or so.  That should resolve the biggest problem area and it shouldn’t be a super partisan issue.  We were very aggressive buying bonds only after rates got way higher, so we were conservatively positioned coming into this mess and we’ll get through it.  As volatility spikes, our existing options might show short-term mark to market losses, which reverse at expiration as time value and volatility values go to zero.  Hopefully this update helps a bit and as always, we will keep you very well informed of any major changes or events as things evolve.


Value After Hours Podcast