Financials: it all comes down to liquidity

Rocchino Contangelo, your assessment of the trend in interest rates last Monday was correct. How do you see things developing further? Can you talk about this for us?

Rocchino Contangelo (RC): Until shortly before the effective decision, it was not clear whether the US Federal Reserve would raise its key interest rate due to the current banking situation. In the end, its focus remained on combating inflation and it raised interest rates by 25 basis points. This is what we had assumed in our analysis. In addition, the SNB has also opted for this approach and increased interest rates to 1.5%. There is currently greater focus on price stability. However, this can change quickly, depending on the banking situation.

What are the downstream effects of these decisions?

RC: We believe that the Fed has opted for a "hike-and-see" position and is examining the situation in the banking sector more closely. In addition, this means that the risks of recession are increasing. After all, economic growth is also caught between price and financial stability, and is slowing down due to higher interest rates and deteriorating financial conditions (see chart). In this environment, both companies and consumers are investing, purchasing, consuming, building and acquiring less due to rising capital and financing costs.

At the same time as Fed Chairman Jerome Powell, US Treasury Minister Janet Yellen spoke. Among other things, she qualified the comprehensive deposit guarantee with US banks. This may represent a slightly higher risk for all banks. Comprehensive deposit guarantees could also have led to misincentives, known as moral hazard. In our view, it makes sense for Yellen to review this situation and examine deposit guarantees that are in the interests of the stability of the banks and the financial system and, last but not least, take into account general economic interests.

Andreas Giger, as a banking expert, how do you assess the current crisis?

Andreas Giger (AG): The Silicon Valley Bank (SVB) problems were not all that unexpected for us in global research. We conducted a fundamental assessment at the end of last year and reduced our positions in the active equity fund in good time. The problem with SVB was the one-sided focus on both the credit and deposit side in growth and venture capital industries, which were increasingly suffering from a financing bottleneck after the turnaround in interest rates.

Against this background, the development towards a crisis would not have been indicated. Although a handful of other banks are also having liquidity issues, the institutions concerned are all in special situations. This is now primarily a crisis of confidence in the liquidity of banks. The vast majority of banks in the affected markets meet the regulatory requirements for liquidity and capital by far, even in realistic stress situations. It is therefore not a general question of solvency.

What are the consequences of this? How will the regulators react?

AG: Apart from the fact that at least two prominent bank names (SVB and CS) will disappear, this could also lead to a further tightening of regulatory requirements, both on the liquidity and on the capital side. At present, a possible expansion of deposit insurance (FDIC) or even temporary sovereign guarantees may be considered in the USA, at least in an absolute emergency. However, this would raise the long-term question of creditworthiness and actual financing. In the interests of a prosperous economy and thus also in the interests of bank shareholders, sovereign and regulatory interventions should primarily focus on liquidity-promoting measures and more optimal incentive systems.

What will happen to the AT1 securities (contingent convertibles) that were also severely affected by the Credit Suisse case?

AG: Of course, this is also a very important question for pure equity investors due to the risk of dilution. AT1 yield premiums are currently very high by historic standards, and it can be assumed that banks will not primarily make decisions on strategic capital adequacy dependent on short-term market movements. In crisis mode, banks seek to preserve capital, while in the good phases of recent years they have carried out share buybacks.

How do you see the further development for banks and financial stocks in general?

AG: Nervousness is likely to persist, particularly in US, European and Japanese bank equities. The markets are currently focusing on Deutsche Bank. We expect the current exceptional situation to calm down gradually. US banks will no longer be able to expand their interest margins so much compared to the last rounds of interest rate adjustments. In addition, provisions for credit defaults will increase. Both will depress banks' profits. 

Which stocks within the financial sector offer more stability?

AG: In terms of regions, European and Asia-Pacific bank stocks should look better than US ones. They are less advanced in the current interest rate cycle, so there is a greater chance of positive surprises in the coming publications of results. Less liquidity-sensitive financials such as insurance should also offer a little more certainty, while at the same time also offering above-average market sensitivity.

Rocchino, how are you positioned in the active equity sector with the portfolios?

RC: Overall, our positioning in our active global and Swiss equity strategies remains defensive. From a global valuation perspective, we are more exposed to financials in Europe and Asia and within the financial sector, especially in securities that are less sensitive to interest rates and liquidity, such as insurance.

In general, a closer look should now be taken at the equity valuation and the estimated earnings expectations should be viewed with caution given the higher recession risks.

Volatility is likely to continue, which opens up opportunities for high-quality companies with strong balance sheets. We also see that quality stocks are currently valued better. We believe that this will continue and our focus remains on selecting securities according to quality equities with relative low valuations. 

Finally, it should be noted that the global equity market, measured using the MSCI World, has been trading positively since the beginning of the year. Despite these volatile markets, exciting and rewarding investment opportunities are emerging, especially on the active-fundamental side!

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