SustainAbility: SVB Special – It’s déjà vu all over again!

Yogi Berra was a baseball catcher for the New York Yankees. He won the World Series championship 10 times, more than any other player in baseball history. If this wasn’t enough, he also was a provider of humorous and profound quotations, many of which have resonance as an investor.

The quote in the title of this blog, and others in this note, can be interpreted in several ways but is often taken to mean that history does indeed repeat itself. It has certainly felt that way in the last few days since US Silicon Valley Bank (SVB) – a bank that many would not even have heard of until this month – had to be taken into receivership.

For those investors who managed money through the financial crisis, this has brought back many unhappy memories. We are all a product of our own experiences which can shape our perception and responses to events, sometimes in a good way and sometimes not.

The great financial crisis of 2008 was born from a systemic flaw in the banking system, which had become too indebted and dependent on illiquid, hard-to-trade assets. These assets were linked to the broader housing market which, as the value of houses fell, created a feedback loop between banks and the real economy.

SVB is a story of a business with a unique, technology-orientated set of customers and a way of managing risk which now appears to have been unwise. It is in this combination the bank appears to have failed. The direct read across to other banks will be known relatively quickly, but this looks unlikely to have been a pervasive issue.

There may well be some indirect consequences for investors, however. Some commentators will use this to point out the stress the financial system is under after the recent rapid rise in interest rates. We saw this in the UK after the budget delivered by Liz Truss and her government last year, when the Bank of England had to step in to support the bond market. These signs of stress may encourage central banks to slow the pace of future interest rates, perhaps at the cost of being able to control inflation.

Stresses in the banking system may also make banks themselves more cautious to lend, creating a drag to future economic growth. It may also be that the banking sector itself becomes more concentrated with assets migrating to the larger, more heavily regulated banks.

The decision of the US Federal Reserve to effectively make good all depositors in SVB (but not, rightly, equity investors and all debt investors) will also trigger plenty of commentary. The decision not to bail out Lehman Brothers is still hotly debated 14 years later.

As with most events of significance, they will only be understood in the fullness of time. For our sustainable strategies, we are not investors in SVB, nor in any of its close peers, and no company we invest in has direct exposure of any significance to the bank.

When you come to a fork in the road, take it

The complexity of the variables impacting markets was already high, with SVB now bringing something else to consider. At the core of the dilemma facing markets is the ability to define the long-term outlook for three of the key variables in investment decision making: growth, inflation and interest rates.

These three variables are of course linked and solving one of them makes the other two more predictable. As we stand today though, it isn’t clear to investors where these three elements will land. Will we have a recession? Will inflation fall back to the targets set by central bankers? What will be the level at which interest rates will peak? These are all questions whose answers will become clearer as 2023 progresses, but for now they remain the subject of much debate.

In recent months we have seen markets flit between different outcomes for these variables. December was a month of recession worries (lower growth, lower inflation, lower interest rates), January and February months of immaculate disinflation (steady growth, lower inflation, lower interest rates), whereas March has been a stronger economic outlook (higher growth, higher inflation, higher rates).

The portfolios required for each of these scenarios are quite different, not just in asset allocation but also within each asset class. This suggests a degree of breadth and open mindedness is needed when considering how best to position funds. As Yogi Berra noted, when you come to a fork in the road you do ultimately need to take it, and at some point markets will. For now, they are still deciding.

The future ain’t what it used to be

Inherent in investing is the future. As other writers have noted, 100% of what we know about an investment is in the past, and 100% of its value is in the future. We therefore have to consider the path of future events, even if they are uncertain. The problem is, as Yogi says, the future ain’t what it used to be; it is changing all the time.

In early 2020, the outlook for the global economy looked strong. Then Covid fundamentally changed that. In early 2022 when we were coming out of Covid, Ukraine was invaded. The future again changed quickly and profoundly.

That the future changes all the time should not be an impediment to successful investing. Some things are constant, whether they be brands we see in supermarkets, the desire to experience new things, or the ingenuity of companies to adapt to whatever problems are thrown at them. For us as sustainable investors, our roadmap is the move to a cleaner, healthier, safer and more inclusive society. Each of these variables has been demonstrably positive generation by generation and we think it highly likely it will remain so in the future.

If the world were perfect, it wouldn’t be

The investment equivalent of this saying is you pay a happy price for a cheery consensus. Put another way, the investment environment with no uncertainty is one of no opportunity. Investments become mispriced, thereby presenting opportunity, when things aren’t certain. We saw this during the pandemic, which in hindsight was a significant opportunity to buy great businesses at low prices.

The acceptance of future returns being dependent on the current level of uncertainty, and the ability to operate in a contrarian way relative to this, is perhaps the most underestimated and important skill in investing.

Whilst we do not believe the events of the last week have created an opportunity on the scale of the pandemic, and it will take longer than a few days to understand fully the events of the last week, there could be opportunities which we will be open minded and balanced in considering.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.