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By: Steve Sosnick Chief Strategist

Under normal circumstances, investors spend their days trying to maximize the returns on their capital. They manage a delicate tradeoff between risk and return, hoping to utilize their funds as efficiently as possible given their risk tolerances and mandates. But there are times when that balance shifts abruptly to concerns about risk, superseding the usual hunt for returns. We’ve been in the midst of one of those times since last Thursday afternoon.

A bank run is a flight to safety writ large. We don’t normally concern ourselves with the safety of our bank deposits. That is especially true for most people since FDIC insures bank deposits up to $250,000 (SIPC insurance has the same limit for cash). The problems with Silicon Valley Bank (SIVB) arose when customers with far greater balances all rushed for the exit at the same time. No one wants to bear risk on their idle cash, and there was a well-founded perception that large depositors were at risk of losing a significant piece, if not all, of their deposits.

At such moments, concerns about the return OF one’s capital overwhelm considerations about one’s returns ON capital.

Banks have a fundamental concern. They tend to borrow short-term, either through deposits or in money markets and lend long-term by making corporate or mortgage loans. The duration of those long-term investments makes them more vulnerable to mark-to-market losses when rates rise and are almost certainly less liquid than demand deposits. That’s a risky setup anytime, and especially when we have an inverted yield curve. In that situation, a banks cost of funds rises while the current value of their long-term assets shrinks.

The activities of the Federal Reserve, Treasury Department, and FDIC went a long way to assuaging the risks to depositors. By assuring that all depositors of SIVB and Signature Bank (SBNY) will be repaid in full, they essentially waived the FDIC limit. That should limit the incentive for depositors cause bank runs to protect their funds. Yet their actions did nothing to assuage nervous bond and stockholders. Under bankruptcy rules, if bondholders aren’t made whole – and it is unlikely that will be the case – stockholders are wiped out.

This morning we saw visceral fear around bank stocks. The government secured against a run on bank deposits, but their actions did nothing to stem a run on bank stocks. As I write this, KRE (the SPDR S&P Regional Banking ETF) is well off its lows of -15%, but still down more than -8%. Investors sought protection with volatility products and short-term Treasuries. We saw 2-Year Notes briefly tick below 4% this morning – they were yielding over 5% as recently as Thursday – before bouncing back to about 4.18% as I write this. That’s still a drop of roughly 40bp today. The Cboe Volatility Index (VIX) crossed 30 for a brief period of time shortly after the open and remains above 26 right now.

Regarding these themes, we have continually noted that if investors are having difficulty pricing relatively risk-free assets, it is extraordinarily difficult to price riskier assets like stocks. We also noted that there seemed to be a sale on volatility just over a week ago. “Bank run” was by no means a factor in our volatility assertion, but a general complacency was.

At some point, stock and bond investors with holdings in regional bank instruments will make sober determinations about the inherent values of those assets. Right now, they have neither the time nor ability to do that for all their holdings. The market will sort out the banks that are being unfairly jettisoned as risk aversion is the mindset. That will signal a return to the usual focus of return ON capital rather than a panicky concern about return OF capital. But it is difficult to know the time period over which that shift will play out.

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Once More, If You Can’t Price Risk-Free Assets…
Aftermath Of A Big Wake Up Call
Goldilocks Comes Out Swinging