Insights from the Trail - 17/3/23

In markets this week –

Happy St Patrick’s Day! Unfortunately, the luck of the Irish couldn’t deliver green for Aussie equities this week, but it was a strong week for US equities (despite bank weakness) and Gold.

This week all investors focused their energy on banks. Silicon Valley Bank (SVB) was bailed out by the Fed after investing liquid deposits in long dated fixed rate assets. The Fed stepped in to guarantee customer deposits and opened a liquidity facility for other struggling banks. The Swiss central bank also injected $81 billion of liquidity to sure up Credit Suisse. While the financial system can handle the collapse of SVB, the collapse of a systemically important bank like Credit Suisse would have much broader consequences…

In other news, the European Central Bank followed through with a 0.50% interest rate rise despite shaky banks. But global bond yields have collapsed with investors now expecting a pivot to rate cuts much sooner. In Australia, the RBA’s April rate decision has been made harder after the ABS reported a fall in the unemployment rate this week.

Three other things that got the team talking this week –

1.     Small banks feeling the pain, but this is not GFC 2.0

The SVB/other bank collapses dominated news this week. The Firetrail team were busy investigating whether these issues were isolated or systemic, and whether our portfolio companies are exposed. In short, we are comfortably underweight banks in our portfolios, and our holdings have zero to very minimal exposure to SVB.

But what actually happened? When interest rates are persistently low, a bank can juice returns by investing short-term customer deposits into longer-term fixed rate loans/bonds, earning a ‘maturity premium’. But when interest rates suddenly rise, the long-term bonds fall in value and the bank suddenly has less assets to cover customer deposits.

2022 saw the most aggressive interest rate hikes in history, and the value of long-term bonds held by banks has fallen significantly. SVB was over-invested in long-term securities and suddenly didn’t have the assets to cover customer withdrawals. It is important to note there are strict regulations for larger banks so mismanagement like this doesn’t occur. SVB fell outside these regulations.

2.     Goods demand is slowing, but travel/leisure is flying…

Post-COVID travellers could not care less about bank asset/liability mismanagement – they’ll be at the beach bar! Air travel is surging and still has a way to go before reaching pre-COVID levels in most regions. The US has led the way and revenue per kilometre is now back to 2019 levels. But Australia still has some ground to make up. Strong demand and lighter competition in the Australian market has Qantas (held in the Firetrail High Conviction and Firetrail Absolute Return Funds) reaping the rewards.

3.     Investors are seeing the glitter in gold…

Gold has been the ultimate defensive asset and store of value for millennia. Recession fears and cracks in the banking system have led to a spike in the gold price from $1,650 to $1,919 in the past 6 months. We think gold plays an important defensive role in portfolios. Gold miners with high-quality assets like Newcrest Mining (held in the Firetrail Australian High Conviction and Firetrail Absolute Return Funds) are set to benefit from heightened uncertainty and a stronger gold price. We published an insight piece on the case for gold in 2023 this week, which you can read here: If it glitters, it's Gold.