Silicon Valley Bank Run Crisis: Will the US Recession Arrive Soon?

Hello everyone, I'm Changqiao Dolphin. Here's the weekly market portfolio strategy. Key information is as follows:

1) The Silicon Valley Bank run crisis, although quickly resolved, suggests that risks around the "technology and government bonds" sectors have not yet been cleared. Considering the possible proactive change in the bank asset allocation structure in the US, balance sheet risks remain, and Changqiao Dolphin tends to understand the subsequent impact of the run crisis with more cautious thinking, and advises against bottom-fishing.

2) Based on the accumulation of macro risks last week, Changqiao Dolphin took a few days to adjust some low-allocated stocks that were originally betting on valuation repair. They were mainly concentrated in Chinese concept stocks and new energy, and some of these companies either have poor competition expectations or weak fundamentals. After they left the valuation repair, there are difficulties in realizing the performance, so they are temporarily adjusted out under macro risks. Details are shown in the following content.

4) This week is another week of concentrated release of high-frequency data on financial reports and macro indicators: On the macro side, US CPI, PPI, and retail data are worth high attention; on the financial report side, the main reports will be from Li Ning, Ke.com, Yuewen.com, and XiaoPeng, among which Li Ning and Ke.com are focused on performance repair progress and outlook for performance recovery and inventory turnover. XiaoPeng's fundamentals are still in the bottoming status, and there is little hope in the short term, only the opportunity to see how its organizational restructuring may help.

Details are shown below:

I. Will SVB accelerate the arrival of the US recession?

If Powell's congressional testimony is hawkish and employment remains strong, it is expected to be a "negative"; While SVB suddenly becoming insolvent overnight is a huge event beyond market expectations and may be a sign of a turning point in the market's trading logic.

Changqiao Dolphin mentioned in the US macro overview "Endless Strife in 2023: Is the US market stagnating, deep in recession, shallow in recession or slightly growing?" that from the macro debt perspective, the major risk in the United States should be federal government debt behind the high level of government bonds, and the risk of bank credit assets. In a true high-interest rate environment, if residents no longer continue to borrow heavily, the United States may look more like a mild recession with a slow-growing income statement rather than a deep recession on the balance sheet.

However, the problem exposed by Silicon Valley Bank (SVB), the 16th largest bank in the US by assets (similar to the ranking of Beijing Bank in China), is related to the bond market:

Liability side: depositors are all start-ups and venture capital firms in the technology industry, and the funding stress is due to the recent sharp drop in valuations in the technology industry in both private and public markets, which is similar to the large layoffs in US tech stocks. This is not a new issue;
Asset side: the loan business did not have any problems, but the problem is related to the US government bond market - SVB holds a high allocation of held-to-maturity (HTM) bonds and available-for-sale (AFS) bonds, and the Fed's significant interest rate hike and yield curve inversion have caused significant long-term floating losses in its HTM and AFS positions. But the resonance of the two created an urgent need for withdrawal for depositors, and SVB quickly ran out of cash, forcing them to sell off their debt assets and seek refinancing. With a large amount of uninsured deposits, high-value depositors found that their deposits might not be withdrawn at all, leading to a bank run crisis.

Faced with this sudden liquidity and trust crisis, the U.S. Department of the Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) acted swiftly and decisively:

The FDIC deposit insurance fund (funded by premiums paid by the U.S. banking industry and the fund's own investments) was used to meet depositors' withdrawal demands so that they could withdraw every penny of their money without regard to the deposit guarantee limit of $250,000, while the shareholders and some creditors of these banks were left to fend for themselves.
To prevent the crisis from spreading further, the Federal Reserve also allowed FDIC-insured liquidity-absorbing financial institutions to borrow money from the Fed for one year using their own assets as collateral. The Fed's lending program will last for at least one year.

The central bank's lending terms were very generous: any of the assets that the Fed's open market operations publicly operate can be used as collateral, and the value of the collateral is based on face value rather than market price. The borrowing cost is the overnight rate plus ten basis points, and there are no other fees. Early repayment can be made without penalty. This was much better than SVB selling assets at market prices and turning their paper losses into real ones.

The reason the Fed did this was that, as revealed in the U.S. banking industry's big book, not only did Silicon Valley Bank have similar floating losses, but the floating losses of the HTM and AFS assets of the entire U.S. banking system were also quite large under the massive amount of government bonds with rising Treasury yields. By the third quarter of 2022, the paper losses exceeded $620 billion.

At the same time, American depositors have been withdrawing money since 2022, especially those who are not insured by the $250,000 FDIC limit, and the pace of withdrawals has been even faster, causing the balance of U.S. bank deposits to decline at a high level.

It can be imagined that if the Federal Reserve does not place such an insurance barrier, there will be more high-value depositors without insurance who will run to the bank to withdraw money.

After the weekend scare, U.S. government agencies acted swiftly and decisively to resolve a potentially contagious liquidity crisis in the banking industry. But whether everyone can continue to follow their business as usual after this crisis remains to be seen.

Dolphin believes that after this crisis, banks need to consider possible changes in their behavior: The problem revealed by this run is that banks' actual assets are far from being as good as their book value (especially in traditional, relatively safe bond assets). And while the Fed's fallback policy is said to be at least one year, it should also be considered that some banks with problematic asset allocation structures within this period of continuous inverse yield curve risk in bond yields will also take the initiative to repair their asset-liability structures, such as by selling loss-making bonds, tightening credit expansion, increasing capital and shares, etc., to increase the proportion of capital and effectively improve capital adequacy.

If the subsequent scenario is such a deduction, it means that under the high-interest environment of the banking industry, besides the increasing credit impairment risk and the dilution of equity through capital increase and share expansion, credit prudence contraction will naturally also affect downstream entities, and this event may accelerate the coming of the U.S. economic recession.

As seen, after the SVB incident broke out, the 10-year Treasury yield quickly fell from 3.93% to 3.7%; at the same time, the short-term 2-year Treasury yield fell even faster, implying a reset of short-term rate hike expectations.

Overall, the trading terminal is beginning to deduce rapidly to the recession logic, which is different from the previous round of China's asset appreciation under the light recession logic and the stagnation of US assets under the light recession logic. With the balance sheet hidden worries, this recession has caused a global asset sell-off.

This crisis of liquidity squeeze shows that the risks around "technology and treasury bonds" have not been cleared yet. Given the continuous changes in the asset allocation structures of the U.S. banking industry, the risks of the balance sheets are still there. As a result, Dolphin Finance prefers to use a more cautious approach to understand the aftermath of this liquidity squeeze crisis and does not easily seize opportunities.

Second, another month of job explosion, is inflation going to end?

The February employment data came out with a still overheated growth rate, with a single-month increase of 310,000 people, even if it did not consider the extreme increase of 500,000 people in January, 310,000 people were still in the high central position for previous months of 250,000 people.

However, combined with newly released figures for job vacancies in January, it can be seen that the majority of the previous month's employment growth was due to filling previously existing positions, rather than a net increase in job demand by businesses, which is not necessarily a bad thing and can rapidly ease the tension in the job market.

And the subdivided sectors of newly added employment are seeing more net layoffs - last month mainly concentrated in some subdivision of the finance field and the entire information industry, this month in addition to the net layoffs of the information industry widened, financial services became an overall net layoffs, and transportation and warehousing and the entire manufacturing industry also entered a net layoffs state. If we further break it down, we can see that the net layoffs in durable goods manufacturing mainly occur in the automotive sector, while non-durable goods manufacturing majority of sectors are beginning to see net layoffs; white-collar positions in commercial services, such as IT technology and finance, are also beginning to be laid off, but there are still many new jobs in blue-collar temporary support;

The industries with the most new jobs are still concentrated in the healthcare sector of the education and healthcare industry. In detail, there are many new jobs in hospitals, temporary relief, etc.; there are a huge number of new jobs in the catering sector of the leisure and hospitality industry, and there are also many new jobs in the hotel sector.

From the current employment recovery progress in various industries, the transportation and warehousing industries are still overloaded with personnel in January, and apart from the layoffs in February (concentrated in the freight field), it is feared that layoffs will continue in the future; other industries such as automotive parts, commercial services, and information have significantly more employed people than before the epidemic.

Layoffs in the automotive manufacturing and information industries have already begun. Currently, only the commercial service industry has not yet happened as a whole, but considering that the new demand is mainly temporary support positions such as administrative office and recruitment, after the economy slows down, this type of demand may quickly decrease. But the leisure and hospitality industry and medical and healthcare social relief obviously lean towards rigid demand, and job demand is difficult to be extinguished due to interest rate hikes.

However, in the case of such structural unemployment and employment, as the Dolphin previously stated, the overall speed of new increase in the United States did not show the same level of heat as employment growth. In February, the hourly wage growth rate slowed down month-on-month, and the 0.2% month-on-month corresponds to a year-on-year growth rate of 2%. The Fed's control target should be within 0.3% on a month-on-month basis, which is a relatively good message.**

Overall, after rapidly filling the original stock job positions in these two months, the tightness of the employment market has begun to ease, and some industries have begun to show a trend of net layoffs. However, the job demands of the two major industries of leisure and hospitality and healthcare relief are rigid, and the absolute value of unemployed people looking for jobs is less than 6 million, which is still small compared to the more than 10 million job vacancies waiting to be filled on the market. If the overcapacity industry layoffs cannot be sped up, it is estimated that this supply shortage will take some time to digest.

However, since the employment contradiction this time was biased towards structural employment and unemployment, the final salary increase did show cross-industry transmission, but the spiral of salary-inflation did not appear.

The two events in the US stock market are linked together: on the one hand, the US banking industry is expected to face a liquidity crisis, and on the other hand, the job market still needs high interest rates to maintain a period of time. It is estimated that the Fed's compromise measures to raise interest rates may not be as high as previously imagined. The possibility of speeding up interest rate hikes mentioned by Powell on Monday may be reduced. III. Combination Adjustment

Based on the potential risk of accelerating interest rate brought by Powell's speech on macroeconomics last week and the upcoming employment data released on Friday; Domestic assets have entered the stage of basic repair and realization, and via JD.com's financial report, it is obvious to see the intensification of competition in the domestic channel retail sector. The risks of Beta and Alpha are changing and increasing. Therefore, the Dolphin concentrated on the combination adjustment last week.

In terms of the overall structure, after the significant repair of domestic assets, coupled with the slow performance realization speed and the difficulty of industry competition exacerbated, the Dolphin believes that the risk of a correction is higher than that of US stocks. Therefore, the Dolphin cleared out Chinese Internet assets and invested mainly in e-commerce and retail assets, followed by assets with poor competitive patterns like new energy, most of which were biased towards the logic of valuation repair when they were adjusted. Due to the weak fundamentals, low allocation recommendations have been given.

IV. Alpha Dolphin Combination Income

Within the week of March 10th, the Alpha Dolphin combination fell by 4.2%, slightly lower than the S&P 500 (4.5%), significantly better than Heng Seng Tech's 10%+ decline, but not as good as the Shanghai and Shenzhen 300 (-4%).

Since the beginning of the combination test to last weekend, the absolute income of the combination is 11.3%, and the excess income compared to the benchmark S&P 500 index is 19%.

V. Individual Stocks and Industries Fall Amid Macro Risks

Last week, most of the stocks with significant declines were growth stocks with centralized cash flows in the future and stocks that had previously risen significantly. Companies with less declines were mainly those that had not previously risen much, regardless of the quality of their fundamentals. As a whole, whether it was the degree of decline or the risks of individual stocks and industries, such declines were biased towards the overall killing of valuation under macro risks.

For the reasons why companies with significant rises and falls came about, the Dolphin has sorted it out as follows for reference:

VI. Combination Asset Allocation

After the Alpha Dolphin combination underwent an adjustment, a total of 22 stocks were allocated, of which the rating for the standard package remained at 7, and the rating for the low allocation decreased from 27 to 13. The rest were gold, US bonds, and US dollars. As of last weekend, Alpha Dolphin's asset allocation and equity asset holdings are as follows:

VII. Key Events This Week:

Macro-wise, U.S. CPI data for February will be released on Tuesday night, and retail and PPI data will be released on Wednesday night. On Wednesday, domestic social and retail data for January and February should be released. The observation strategy is still the same, focusing on the recovery progress in China and the progress in inflation control in the U.S.

As for individual stocks, Dolphin is paying attention to four companies that will release their financial reports - Li Ning, Beike, Yuewen Group, and Xiaopeng. The key information to be watched out for has been listed for everyone. For details, refer to the following figure:

Please refer to the following articles in the recent Dolphin Investment Research Portfolio Weekly Report:

"After Selling Exhaustion, Global Markets Can Finally Breathe"")

"Confirming Inflation, Reversing Fortunes - An Opportunity in Disguise"

"Setting Inflation Aside, Signals in Alibaba and Baidu are More Important"

"Hong Kong and U.S. Equities are both Weak, Are Wolves Coming?"

"The High-Frequency Macro Made a Puppet, and the U.S. Stock Market is a Puppet Market"

"Believing in a Single Green Candle, Tesla Leads U.S. Stocks to Comeback?"

"How Far Away is the End of the 'Danger' of the U.S. Stock Market?" 《Is the hammer of performance just around the corner when US stocks don't have a "red New Year"?》

《What's behind the stagnant US stocks?》

《Has CPI fallen back enough for the Fed to be at ease?》

《Is it easy to eradicate service inflation? Beware of market overcorrection.》

《Hong Kong stocks finally have a backbone? Independent market still has further upside potential.》

《Darkness before dawn: the mentality is focused on darkness or dawn.》

《Can emerging markets bounce around for much longer as US stocks are hit hard by reality?》

《Global estimate repair is good news? There are still performance checks to be made.》

《China's asset violence pulls up, while China and the US are two different worlds.》

《Did the giants Amazon, Google, and Microsoft fall? Meteor showers still fall on US stocks.》

《Policy shift expectations: unreliable "strong US dollar funding" GDP growth?》《Southward takeover vs Northward escape, is the moment to test "determination"》

《Slow down rate hikes? The American Dream is shattered again》

《 A fresh look at a "iron-blooded" Fed》