Bank Runs and March Winds
Q1 2023 Passive Perspectives
- The technology sector provides refuge during the banking crisis, with Apple and Microsoft driving outperformance
- The emergence of ChatGPT, the artificial intelligence chatbot, adds fuel to the technology theme rally
- The Fed continues to fight inflation
Introduction
A well-known saying is that March winds and April showers bring May flowers.March proved to be turbulent, particularly for the banking industry. Trouble within the banking system, starting with the collapse of Silicon Valley Bank(“SVB”), left markets slightly rattled, resulting in the Federal Reserve’s (the“Fed”) decision to scale back on the aggressive rate hike cycle that it has pursued since 2022.
Apple and Microsoft dominate the FAANG
Mega-cap tech stocks served as a haven in March during the collapse of SVBand the period of increased volatility experienced by the banking sector. As a result, investors flocked to the safety of cash-rich, tech stocks, specificallyApple (AAPL) and Microsoft (MSFT), whose weights continued to grow in theS&P 500 to 7.0% (AAPL) and 6.2% (MSFT).
Where the FAANG1 stocks once dominated the tech sector, AAPL and MSFT, with a combined market capitalization of over $4 trillion, have split from the group and now account for 13.2% of the S&P 500. The already tech-heavy Index has become even more concentrated, posing a challenge to investors looking for diversified exposure to the U.S equity market. Nevertheless, investors continued to pour capital into the tech sector, which has gained momentum since the Fed Indicated its intention to slow or pause rate hikes.
Exhibit 1. Core Index Comparison
Banking Sector Gets Fed Up with Rate Hikes
The Fed’s most recent interest hike period (March 2022 – March 2023), as illustrated in Exhibit 2, was the fastest rate hike cycle over the last three decades. The Federal Open Market Committee raised target interest rates to 4.75%-5% from a meager 0.5% in March 2022. This recalls a similar trend from the 1980s when former Fed Chair Paul Volcker also pursued a series of aggressive interest rate hikes. While deemed necessary to control rampant inflation, the Fed’s recent monetary policy tightening has hurt many regional banks, inducing significant mark- to-market losses in their asset portfolios, which often include allocations to treasury securities. Furthermore, bank runs from panicked depositors created a downward spiral and led to the collapse or near-collapse of several regional banks. It began with Silvergate, a bank known for its largely crypto client base, followed by the U.S. government takeover of SVB and the subsequent demise of Signature Bank. Then the contagion spread to global investment bank, Credit Suisse, forcing its eventual acquisition by UBS. Whether these banks have set off a broader domino effect within the financial sector will be closely watched as the year progresses.
Exhibit 2: Historical Interest Rate Hike Periods by the Fed
Affinity Thematic Lens
Using the Syntax Affinity® platform, we can view the market through a wide range of unique thematic lenses and analyze the performance of groups of relevant companies. Themes are often persistent in the markets for several months or quarters; related stocks can persistently out (or under) perform. During the first quarter, the following emerged as themes to watch:
Technology Revolution
Microsoft-backed Open AI, the company behind ChatGPT and other AI projects, dominated headlines during the first quarter, fueling the performance of chip makers such as NVIDIA, Advanced Micro and Intel, which rose 94%, 53% and 25%, respectively. Despite the subdued economic outlook, the performance of these tech stocks remained resilient as investors expressed excitement about this revolutionary technology. Outperformance in groups within the Syntax Technology Revolution Theme includes companies which were identified as having business exposure to 5G-enabling technology, high-performance compute and artificial intelligence.
Clean Energy
In examining the Affinity Clean Energy Lens, electric vehicles gained traction in the first quarter, with Tesla rebounding and recovering some of its losses from 2022. Tesla was up 71.8% year-to-date as of the end of March. Alongside Tesla, other electric vehicle companies such as Lucid also posted positive returns but have yet to recover to their 2021 peak prices.
Using the Syntax Affinity® platform, we can view the market through a wide range of unique thematic lenses and analyze the performance of groups of relevant companies. Themes are often persistent in the markets for several months or quarters; related stocks can persistently out (or under) perform. During the first quarter, the following emerged as themes to watch:
Technology Revolution
Microsoft-backed Open AI, the company behind ChatGPT and other AI projects, dominated headlines during the first quarter, fueling the performance of chip makers such as NVIDIA, Advanced Micro and Intel, which rose 94%, 53% and 25%, respectively. Despite the subdued economic outlook, the performance of these tech stocks remained resilient as investors expressed excitement about this revolutionary technology. Outperformance in groups within the Syntax Technology Revolution Theme includes companies which were identified as having business exposure to 5G-enabling technology, high-performance compute and artificial intelligence.
Clean Energy
In examining the Affinity Clean Energy Lens, electric vehicles gained traction in the first quarter, with Tesla rebounding and recovering some of its losses from 2022. Tesla was up 71.8% year-to-date as of the end of March. Alongside Tesla, other electric vehicle companies such as Lucid also posted positive returns but have yet to recover to their 2021 peak prices.
Real Estate
Since the pandemic, many companies have adopted remote and hybrid work practices, leading to reduced demand for commercial real estate. To make matters worse, rising interest rates have resulted in lower commercial real estate valuations. The Affinity REIT Thematic Lens reflects these developments, showing negative returns from commercial and office real estate companies, such as Boston Properties and W.P Carey, which were down 27.3% and 12.1% respectively, for the quarter. Commercial real estate will be an industry to monitor going into the second quarter.
Banking
Facing the pressure of rising interest rates, the financial sector was by far the biggest underperformer during the first quarter. Over this period, the non-real estate banking segment declined 30%, while securities brokers and dealers were down by 25%. The seemingly isolated bank failures in March led to a significant deterioration in investor confidence, and as a result, many banks have continued to underperform.
Caution Required Ahead
The emergence of new technologies such as ChatGPT and slowing rate hikes by the Fed have supported the technology sector’s rallies witnessed during the first quarter of the year. Whether the Fed will continue to increase rates to combat inflation as recession fears mount remains to be seen. Investors should, however, continue to pay close attention to their portfolio exposures to ensure their investment convictions are expressed as intended and that their portfolios remain diversified.
The table on the following page illustrates the performance results for specific themes within the S&P 500. The ability to dissect the market in this manner is made possible through our proprietary classification technology and Affinity platform.
