The following article is based on our recent weekly investment video published March 27, 2023, Weekly Update: Corporate Debt Issuance Slowing to a Crawl
The recent turmoil in the credit markets due to the collapse of Silicon Valley Bank brings to mind Warren Buffett's famous quote, "It’s only when the tide goes out that you learn who's been swimming naked." Investors are asking if the tide is still going out, whether credit seizures in the economy and markets are getting worse, or if the situation is improving.
Jerome Powell's recent press conference shed light on the Federal Reserve's perspective. When asked about considering a 50-basis point hike, he stated that the Fed went with a 25-basis point hike due to the tightening effect from the bank runs on financial conditions. The Fed's language has hinted that they might be nearing the end of rate hikes, but the market continues to price in approximately 100 basis points of rate cuts, creating a disconnect between the market and the Fed.
The situation is reminiscent of 2018, when the market anticipated rate cuts while the Fed planned rate hikes. However, the complete seizure of the junk bond market in December 2018 prompted the Fed to change course in January 2019, using every tool at their disposal to stabilize markets. This raises questions about whether the Fed will once again come around to the market's position.
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To understand the fallout from the Silicon Valley Bank collapse (the 2nd largest bank failure in US history) and other recent banking troubles, we must examine the impact on various debt markets, including investment grade debt, junk bonds, and leveraged loans.
Investment Grade Debt
A comparison of the pace of investment grade debt issuance in 2022 and 2023 reveals a flatlining in March 2023, around the time of the bank's collapse. This divergence could be problematic if corporations cannot issue new debt to retire old debt, potentially leading to a credit seizure.
In March 2023, investment grade debt issuance has reached its lowest point in a decade even worse than March 2020 and March 2018 (see image above). This indicates a freezing of the corporate debt market that has yet to thaw.
Junk Bonds
The junk bond market has also flatlined in recent weeks. Comparing March 2022 to March 2023, the number of deals and total volume of junk bond issuance is on par with the low levels seen in March 2020. This suggests a significant impact on the riskier credit market.
Leveraged Loans
The leveraged loan market, often used by private equity firms to take companies private, has also slowed. Comparing the first three months of 2022 to 2023, there is a significant decrease in debt issuance. In fact, March 2023 has the lowest number of deals and lowest leveraged loan debt issuance in the past decade.
Stock Market vs. Credit Markets
Interestingly, the stock market is displaying less stress than credit markets. The credit default swap indices for investment grade and high yield debt indicate that the S&P 500 should be approximately 5% lower than its current level. Historically, credit markets have been more accurate in predicting future trends.
New Lows and Large Cap Tech
An expansion in new lows in the stock market in March, compared to December and January, suggests that large cap tech is driving the rally. The advance-decline line is negative, meaning that fewer stocks are participating in the rally, and the market is being propped up by a select group of large cap tech companies.
The Role of the Federal Reserve
The Federal Reserve's response to the credit market turbulence and the Silicon Valley Bank collapse will be crucial in determining the future trajectory of the markets. As it stands, the Fed is indicating that it might soon conclude its rate hike cycle, but the market continues to price in rate cuts.
In the past, when the Fed changed course in response to market turmoil, it was able to restore confidence and stabilize markets. The question remains whether the Fed will once again adjust its policy stance to align with market expectations.
Conclusion
The Silicon Valley Bank collapse has had a significant impact on credit markets, with investment grade debt, junk bonds, and leveraged loans all experiencing a downturn in issuance. The stock market has so far been more resilient, but the divergence within the S&P 500 and the negative advance-decline line suggest that the rally may be unsustainable.
The Federal Reserve's response and any further deterioration in the economy will be a key factor in determining the future of the markets. If the Fed adjusts its policy to align with market expectations, it could help stabilize the situation. However, if the disconnect between the market and the Fed persists, further stress and turbulence in the credit markets and the broader economy could unfold.
Investors need to pay close attention to the developments in both credit markets and the Fed's policy stance. Only time will tell whether the tide is still going out, revealing more vulnerabilities in the financial system, or if the situation will begin to improve.
See related podcast: Chris Puplava on Rapid Change to Fed Policy Outlook, Labor Market Turn
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