Friday 31st March 2023
After a storm-tossed few weeks in the markets, this week the winds finally flagged, the seething waves fell back and a new calm set in. Indeed, on Wednesday a fair breeze began to fill investors’ sails, lifting risk-on sectors to a gentle clip (the NASDAQ was up +1.9% over the last 5 days by yesterday’s close, putting it on track for its best quarter since 2020). However, the fortnight began with the stormfront unleashed by Silicon Valley Bank’s demise (covered in our last note) surging across the Atlantic to sweep away 167-year-old institution Credit Suisse over one climactic weekend. The Swiss National Bank’s (SNB) pledge of a $54bn liquidity backstop on 15th March had proved insufficient to staunch Credit Suisse’s free-flowing deposit bleed. The bank was haemorrhaging CHF 10bn (USD 11bn) of deposits a day and by the end of the week its share price was down another -26% (-85% over two years), shrinking its market capitalisation to just $8bn. Fearing the uncontrolled collapse of one of their oldest and largest banks, the combined power of the SNB, regulator FINMA, and the Ministry of Finance stepped in and ordered Credit Suisse’s merger with rival and Zürich neighbour UBS. As the only buyer in town, UBS could drive a hard bargain: it paid just $3.25bn and had the deal sweetened with guarantees and liquidity lines from the regulators who were the insistent matchmakers of this shotgun wedding.
The death of such a storied (read: scandal-ridden) player is always going to be gripping but two things really mattered to global markets in this denouement: the treatment of the different rungs in Credit Suisse’s capital ladder; and whether the bank was just the next domino in a line starting with SVB … and ending in a wider crisis (as with Bear Stearns and Lehman Brothers more than a decade before). Investors were appalled to learn that the takeover deal would write-down $17bn of Credit Suisse’s Additional Tier 1 (AT1) bonds, even though equity holders – junior to AT1s in the credit stack – were not wiped out. This inversion of the ranks suddenly called into question a crucial and hitherto inviolate part of banks’ highly regulated capital. New doubts about the sanctity of AT1s spurred on investors’ hunt for the financial sector’s next weakest link and bank stocks on both sides of the Atlantic began to sink. The reverberations were felt throughout markets. Volatility remained elevated (keeping the VIX index firmly above 20 throughout the week), equities pinged erratically between positive and negative moves, Credit Default Swap spreads surged (especially for banks) and European Investment Grade spreads had some of their most volatile days of the last decade. Interest rate expectations were also notably volatile. On Friday, shares in Deutsche Bank – itself not immune to scandal in recent years – fell as much as -14% intraday. However, as the week progressed and investors were forced to look closer at banks and their balance sheets, they concluded that these really are different beasts from their pre-2008 selves. It helped, too, that the European Central Bank (ECB) and Bank of England were quick to distance themselves from the SNB’s part in the AT1 raid and underscore their own commitment to the securities’ place in the capital structure waterfall. As such, the gusts that had shaken markets all week had begun to dissipate before the weekend, led first by US bank stocks, which turned positive on Friday.
This week brought a lull and from Monday to Wednesday markets were largely becalmed (we even worried for a minute that material for this week’s newsletter was looking a little thin). Equities were range bound (the S&P 500 continued to hover around the 4,000 point mark) and other markets, including USD and gold, traded mostly sideways. With the noise of the banking storm hushed, investors started to listen again to the macro prints and what they said about the likely path of inflation and rates. Last week the Fed added another +25bps to its target rate and consensus is growing that the peak is very much in sight; the recent banking sector turbulence has highlighted the danger of going much further. Markets now expect one last 25bp hike in May but are pricing two 25bp cuts later in the year. This view has encouraged a gentle uptick in risk sentiment, which began to lift stocks on Wednesday; a +1.42% gain on the day took the S&P above its levels before SVB collapsed three weeks ago. It has not all been plain sailing, though. Mixed European inflation data – Spanish CPI almost halved in February but German inflation failed to fall as much as anticipated – yesterday put renewed pressure on European sovereigns, pushing up yields. While today’s strong decline in Eurozone headline inflation (+6.9% in March, down from +8.5% the month before) offers some encouragement, a continued rise in core inflation will keep the pressure on the ECB.
Meanwhile, at the risk of belabouring our already tortured nautical metaphor, on Tuesday an unexpected wind stirred the junks of Hong Kong’s Victoria Harbour and got Chinese tech stocks sailing, taking Asian shares along with them. Sprawling Chinese e-commerce giant Alibaba surprised investors with plans to split into 6 separate entities, divorcing its various verticals from domestic and foreign e-commerce to cloud computing and logistics. Each of this gaggle of baby-Babas will have its own CEO and be able to raise capital independently – and eventually IPO. Investors smiled on the plan: the firm’s New York primary listing climbed +14%. To be sure, there is some business logic to the split – not least as it will make Jack Ma’s labyrinthine empire easier to value, potentially making its capital raising more efficient. But there can be no doubt that it is Beijing officials the company’s leadership are looking to impress, not Wall Street analysts. Jack Ma’s spectacularly ill-advised October 2020 speech bashing state banks and regulators may have been the trigger but the real source of Alibaba’s fall from grace (its share price was down -70% from its 2020 zenith before Tuesday’s news) was regulators’ concerns at its gigantic scale and monopolistic power – and, of course, Xi’s intolerance for the rival power of uppity entrepreneurs like the showboating Ma. Disaggregating the Alibaba colossus will go some way to assuaging these concerns, while Ma cuts a decidedly chastened figure (he has been hiding out in Tokyo and in January surrendered control of Ant Group, the financial powerhouse whose blockbuster IPO Ma’s infamous speech torpedoed). Chinese policymakers had been given first sight of the six-way split – and gave their nod. And in a clear signal that the Communist Party was softening its approach to China’s private sector, the stage had been set for Tuesday’s announcement by Ma’s first – lowkey – visit to China in over a year. Since throwing Zero Covid overboard in November, Beijing has been trying to persuade international and domestic corporates that China is again open for business. Judging by Western business leaders’ attendance at last week’s China Development Forum (Apple’s Tim Cook and Bridgewater’s Ray Dalio were amongst those at China’s answer to Davos), this message has a receptive audience.
However, as these events were unfolding in China, from across the Pacific there came a reminder that Chinese business – especially Chinese tech – is squeezed between a Chinese rock and an American hard place. The US Congress grilled TikTok CEO Shou Zi Chew last Thursday, amidst speculation of a US ban on the video-sharing platform. American officials and politicians fear the app’s ability to harvest US citizens’ data – and, in turn the Communist Party’s ability to squeeze that data out of its parent company, Bytedance – is a national security risk. The app is, we hear, wildly popular with the cool kids the world over; it counts 150 million active users in the US. (There are as yet no plans to shift the Bedrock Newsletter to 60-second video form; we do not fancy ourselves budding ‘finfluencers’). But the congressional inquisition was bad enough that shares in TikTok’s US rivals surged (Facebook’s Meta was up +5.3% on the day). For US companies, too, it was a reminder that they risk similar Capitol Hill scrutiny if they deepen their presence in China. Meanwhile, pressure on Chinese firms is also ratcheting up in Brussels. EU Commission President Von der Leyen yesterday announced the EU would step up efforts to ‘derisk’ its economic ties with China – by loosening them. In the last two weeks, the EU has presented plans to reduce clean energy tech imports from China and more tightly control high-tech trade with the country. Data suggest that China’s economic recovery is proving slower than some rushed to assume at the start of the year. Industrial profits contracted -22.9% in January and February compared to a year earlier and exports have declined in dollar terms five months in a row (as Western consumers ease off their goods consumption). While we have previously cautioned that China’s economic scarring from Zero Covid was too deep for the recovery to be as instantaneous as the policy’s sudden abandonment, we would not bet against the recovery gathering real steam across the year. Indeed, today’s positive PMIs suggest that is beginning to happen.
All in all we welcome a quieter few days in the markets. Investors are right to ignore some of the frenzy that was building in the wake of Credit Suisse’s demise and to judge banks – especially in Europe – to be far safer than on the eve of the 2008 crash. Nonetheless, the last weeks have been another reminder that when rates rise rapidly, something tends to break. This is a warning worth heeding. Corporate leverage remains high this cycle and still-narrow spreads offer plenty of downside. As such, we retain our negative view on credit risk and continue to barbell our fixed income exposure.
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