The failures of Silicon Valley Bank and Signature Bank in March may be triggering the greatest stress to the banking system since the financial crisis in 2008. For the time being, it looks as if these might be isolated incidents, the result of poor risk management practices as opposed to an industry-wide systemic breakdown, but we still don’t know the full extent of the damage.
What we do know is how the U.S. government has responded to the situation. In a matter of days, the Federal Reserve had emergency lending facilities in place to ensure that at-risk financial institutions had more than enough liquidity to function. The FDIC stepped in to guarantee all deposits at the two failed banks. The Fed added $300 billion to its balance sheet in a single week, effectively undoing the last 4 months of quantitative tightening in a single shot.
While the idea of structural and systemic instability in the financial sector is unnerving, there is a silver lining to this for stock investors. As of March 22, the SPDR S&P Regional Banking ETF (NYSEARCA:KRE) is 32% below its 2023 high. Investors are either 1) throwing the baby out with the bathwater or 2) believing that this issue could be more widespread than we currently understand. The latter could certainly turn out to be the eventual outcome, but here are three reasons for the bullish argument today.
Liquidity Leads to Rising Stock Prices
Whenever the Fed steps in to loosen financial conditions, whether that’s via lower interest rates or direct bond buying, the added liquidity has often resulted in gains for risk assets. Both 2018 and 2020 are good examples of this.
In 2018, the Fed was finally attempting to normalize monetary conditions post-financial crisis. At the time, there was a recession looming in Europe and investors feared that this risk could spill over into the United States. In the fourth quarter, the S&P 500 fell by roughly 20% from peak to valley. The Fed quickly turned dovish and markets began pricing in rate cuts instead of hikes. By April 2019, the S&P 500 was back at all-time highs.
A similar story played out during the Covid-19 recession. Stocks had dropped by more than 30% when the Fed cut rates to 0% and the government announced a multitrillion-dollar stimulus program. By August 2020, the S&P 500 again was trading at all-time highs. In both cases, stocks recovered all of their losses in a matter of months.
We could be in the early innings of a similar quantitative easing program today. If the Fed is about to add trillions of dollars to its balance sheet, as JPMorgan suggests, it could fuel a similar rally.
The Government Was Quick to Backstop Downside Risks
In 2008, it took the government months to respond to the financial crisis. In 2023, it took a matter of days. As I mentioned earlier, the government has stepped in to guarantee all deposits at the two failed banks and may yet do so for all banks.
Both the Fed and the big banks have opened up loan facilities to keep the financial system moving and cut off any potential bank runs. This looks like a situation where the powers that be will do everything in their power to mitigate any potential risks.
Bank Failures Are Isolated
Silicon Valley Bank, which catered to tech startups and venture capitalists, and Signature Bank, which was heavily involved in the crypto space, are unique institutions in terms of their client bases. These aren’t your typical community banks that serve the general population. Plus, the primary cause of their downfalls was poor risk management practices.
Thus far, we’ve seen little indication that this is a widespread risk (although we could still see a few more instances arising). It’s entirely possible that we’ve already seen the worst of it. If that’s the case, a 30% drawdown in regional bank stocks may eventually be viewed as an overreaction.
The strategies I use all involve quantitatively driven processes that take emotion out of the question. If investors look past the news headlines, they may find opportunities in equities right now.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.