BACRP - Be Cautious On Deploying Spare Capital

2023-03-20 02:17:48 ET

Summary

• The banking crisis has resulted in a new slate of recommendations to deploy spare capital into suffering bank stocks.
• Inflation and the debt ceiling still pose massive risks to the market over the next several months.
• We recommend for those looking to invest to preserve spare capital and start by cautiously deploying into blue-chip ETFs.

As with any downturn in the market in recent years, writers have jumped into recommending new investments. As seen below, of the top 12 articles on Seeking Alpha, there are several recommendations to make new "bargain bin" investments, especially in the financials sector. That comes with a 15% drop in the Vanguard Financials ETF (NYSEARCA: VFH ).

Seeking Alpha Top Articles - Seeking Alpha

Overview

The market of the past several years has been marked by fear of recession. One that history has shown can be expected , especially after years of easy money. The COVID-19 bear market was the shortest one in history . The era of cheap money has also meant there's a lot of spare capital . Rising interest rates have taken some of that away.

However, there's plenty of money sitting on the sidelines waiting for an "opportunity". Patience is tough and that results in the capital being readily deployed in situations like this.

The Run No One Can Handle

The fundamental issue here, to some extent, is the banking system is built on trust.

One can fill a book with the mistakes Silicon Valley Bank made and one can debate for hours about the upsides and downsides of making those who deposit past the FDIC limit lose their money. However, it should come as a surprise to no one, that the government, which historically has become very afraid of any downturn, offered to cover all excess balances with the FDIC.

Of course in any rising interest rate environment, the naive who expected cheap money to never change are exposed, and cracks in the system appear. UBS and Credit Suisse announced a merger after years of simply awful decisions by Credit Suisse (i.e. waiting to coordinate selling the capital from Archegos' downfall with other banks).

The bigger concern here is what happens to the banks that didn't make bad decisions. First Republic (NYSE: FRC ) might still be doomed according to the market's performance Friday, despite a unique show of support from other banks and the company's history of being a fairly reliable operator, albeit one with a unique clientele .

Should First Republic fail, what stops the run from moving up the chain. Bank of America (NYSE: BAC ) has some of the largest losses among peers . Sure a much higher % of its deposits are FDIC insured, but when everyone around you is panic-ing can you really trust those withdrawing their money to leave the last $250k.

At the end of the day the banking system is based on trust and FRC's share price Friday should be a clear indicator the panic hasn't stopped. Solid deposit outflow numbers are needed across the board, especially at mid-size banks, to indicate the panic has stopped.

Debt Ceiling

Of course it's easy to forget other crisis when you're in the middle of a new one.

The exact date isn't set yet as tax season rolls around, however, the U.S. could face a default as soon as June . A recent Republican suggestion to prioritize paying external creditors China and Wall Street and avoid other government bills to prolong the debt crisis shows how both sides are not expecting a deal within the required time period.

Given growing antagonization between Democrats and Republics, we feel it's increasingly likely for there to be a major standoff. There's already a Wikipedia page for the crisis . It goes without saying that the prevailing economic view is that a U.S. default would be devastating for the U.S. economy and even a standoff that increases the chance of a default would have a major impact.

Inflation

And let's not forget what started this all.

Easy money during the 2020 administration, primarily to businesses as they navigated COVID-19, along with a massively disrupted supply chain , and increased decoupling of the supply chain from geopolitical adversaries, caused skyrocketing inflation from 2020 into 2021-2022. Inflation rates have dropped some but it's clear that's not done.

The Fed has reiterated numerous times its goal to aggressively curtail inflation with massive 0.75% rate hikes. Whether that strategy changes in light of the banking crisis currently happening has yet to be revealed. However, we expect aggressive contractionary actions from the Fed until it is curtailed, especially over the next several years.

Our View

For those who are looking to start investing, we don't recommend permanently holding off. We would recommend the following strategy:

- Pick decline points to invest your capital. i.e. invest 20% at a 15% market decline, 30% at a 25% market decline, and 50% at a 50% market decline.

- Allocate capital to the least risky investments first. Start with a market ETF or financial ETF. Once you hit larger decline levels and it's easier to pick losers and winners, wade into the riskier investments.

Keep in mind timing. We expect the market to be volatile and risky especially into the second half of the year with the debt-ceiling and as investors look for changes in the interest rates and inflation numbers. Keep in mind your personal risk appetite. What if you lost your job? How would that affect your need for capital and investments.

Overall, the takeaway is to avoid jumping in and investing all of your money at once from a small market decline, especially in a market with major risks, and then just riding the continued downturn.

Thesis Risk

The largest risk to our thesis is downturns in the last few years have been short. This might be another great buying opportunity that doesn't get better and those who wait risk missing out and either leaving their capital alone for longer or being forced to invest at a worse price - both disappointing outcomes for them.

Conclusion

As with any prior downturn in the markets, there's a new spate of recommendations to invest. This time, many of them focus on banking stocks, which are at the center of the current crisis. However, for multiple reasons we recommend being extremely cautious about doing that as an investor with cash on the sidelines.

First, the fundamental nature of a run on the banks, in some aspects, is irrationality. Second, there are substantial other risks to the economy (inflation and rising interest rates along with the U.S. debt ceiling). As a result, for those looking to invest, we recommend starting cautiously with lower risk investments and then looking at higher risk investments as the market drops more.

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