Why SVB’s collapse is positive for the overall stock market outlook

  • SVB’s implosion is making scary headlines, but it could actually be great for the stock market.
  • Indeed, the event could trigger a reversal of the main cause of stock market pain in 2022: rate hikes.
  • Interest rates plunged on Monday and expectations are growing that the Fed will halt its aggressive hikes.

THE Silicon Valley Bank implosions, Silvergate Capital and Signature Bank in recent days could make scary headlines. But they could actually be bullish developments for equity investors.

Indeed, the Federal Reserve may be forced to slow the pace of the rate hikes it has enacted since March 2022. This would be good news for investors who have felt the pain of tighter financial conditions, as equities have struggled. started this year.

It would also help alleviate the very pressure that led to the collapse of these institutions. After all, it was the rising interest rate environment that put companies in such a precarious position, as risk-free government bonds began yielding more than their debt. Customers withdrew cash and fled to greener pastures, and the panic situation eventually snowballed into a series of bank runs.

Now, as the prospect of further rate hikes fades, investors are scrambling to reassess what that means for the two main drivers of stock market gains: corporate earnings growth and risk appetite. . Based on Monday’s market action, it’s positive: All three US indices rose, with the more rate-sensitive Nasdaq pacing the gains with a 1.4% increase.

A number of Wall Street firms have already forecast a pause in rate hikes, with Goldman Sachs leading the way.

“In light of recent stress in the banking system, we no longer expect the FOMC to proceed with a rate hike at its March 22 meeting with considerable uncertainty about the path beyond March,” the company’s chief global economist, Jan Hatzius, said in a note to customers.

It’s a big problem. Shares sold off last week as Fed Chairman Jerome Powell presented a hawkish position to Congressleading the market to expect a 50 basis point hike next week, followed by at least two more later in the year.

Now some see the fragility of the regional banking sector, and market expectations began to tilt toward something previously unthinkable: rate cuts later this year. It would be fuel for stocks.

A reversal in key market dynamics

Rapidly rising interest rates throughout 2022 have rattled corporate valuations and sent the broader stock market into a bear market. Now, the exact opposite dynamic is now in play. The 2-year US Treasury yield plunged more than 40 basis points on Monday and has fallen almost 90 basis points since the end of last week. Equities suddenly look more attractive compared to risk-free bonds which have hurt their appeal.

Until the Fed continues its hikes, the upward momentum in rates may have finally been broken, meaning lower interest rates are a possibility.

“Based on the turbulence in financial markets over the weekend and signs of a sudden escalation in risk aversion, we now believe a 50 basis point rally is not on the cards for the week. next and the decision point will be between a 25 basis point hike or a pause,” Barclay’s said in a Monday note. “While we cannot rule out the first scenario, we believe the most likely outcome will be a break.”

There is historical precedent for what investors are predicting. Some have pointed to the Orange County bankruptcy in 1994 as a parallel event to the current interest rate environment.

In 1994, the Fed raised interest rates sharply to slow the economy, raising its benchmark rate from around 3% to 6%. The sharp rise contributed to Orange County’s bankruptcy, and the Fed’s next moves were to pause and then finally cut interest rates in the summer of 1995.

The stock market performed remarkably well in the following years. If the Fed has the same fears that it broke something and decides to tread carefully around further rate hikes, the stock market could be poised for a similar bullish reaction.

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