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Withdrawals – Real and Metaphysical

Withdrawals – Real and Metaphysical

Posted March 15, 2023 at 12:39 pm
Steve Sosnick
Interactive Brokers

Bank runs occur when nervous depositors attempt to withdraw their funds en masse.  But I will assert that a different sort of withdrawal is causing the recent run of market jitters – markets that became addicted to the plentiful liquidity supplied by the world’s central banks on a continual basis for nearly 15 years are now feeling the pain caused by its withdrawal.

To be clear: by no means do I want to minimize or trivialize the excruciating process of substance withdrawal.  I’m blessed to only know of it second-hand.  So I apologize if the metaphor is insensitive or seems inapt, but after careful thought, it’s the best I can come up with. 

Easy money upsets investors’ equilibrium regarding fear and greed.  Low rates require them to take greater risks to earn returns on their investments.  The process can be slow and insidious.  It’s not as though conservative investors turn into gamblers overnight; instead we see a general willingness of all sorts of investors to take on slightly more risk.  A corporate bond manager might take on some weaker credits than normal or pay a tighter spread to Treasuries.  A value stock investor might add more growth stocks to a portfolio.  A stock trader who uses momentum strategies might begin speculating with options. 

Writ large, that allows inordinate amounts of money to flow into sometimes unusual corners of the investable universe.   Like actual water, financial liquidity seeks the lowest level.  When both fiscal and monetary policy were “set to 11”, pumping out money at record paces in 2020-2021, investments of all types rose and certain highly speculative corners of the market flourished.  Ask yourself would we have seen momentum stocks soar the way they did without the pandemic stimuli?  How about meme stocks, SPACs, or cryptocurrencies?  Of course not.

We have already seen substantial declines in the extreme examples mentioned above, along with all sorts of stocks and bonds, as investors adjusted to the withdrawal of liquidity by global central banks.  Rate hikes and quantitative tightening are of course the main culprits.  As the rates on risk-free assets rose, it raised the valuation hurdles for essentially all investments.  We’ve asserted frequently – most recently last Friday – that if markets can’t agree on the price of low-risk assets like short-term Treasuries, it is incredibly difficult to find a consensus on riskier assets.

And now we find ourselves dealing with what most investors consider their safest, most risk-averse asset – bank deposits.  By definition, we hold onto cash or cash equivalents when we don’t want to have that portion of our portfolio bear any market risk.  That is why the events at Silicon Valley Bank (SIVB) and Signature Bank (SBNY) shook markets so deeply on Monday.  We acknowledged that investors’ nervousness showed that for many, return OF capital far outweighed return ON capital.   This morning’s news about Credit Suisse (CS) did nothing to assuage anyone’s fears.   Banking crises make people nervous.  They always have. 

That said, yesterday’s FOMO-driven bounce shows that not all of our old bad habits have been fixed.  There was a well-deserved feeling of relief, based upon the idea that the SIVB crisis might be contained.  But when that morphed into a full-blown, broad-based speculative rally it became evident that traders remain more concerned that they might miss an upswing rather than being sure that the worst of the crises might truly be behind us.  Once again, our admonition that “bear market rallies are short, sharp and ferocious” rings true. 

At some point this crisis will pass.  But until we see a final resolution, banks and investors alike will experience pains from the systemic withdrawal of liquidity.

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The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

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