Banking sector woes lead to investor nervousness, but technology stocks provide a more positive story

As we drew to the end of the first quarter in 2023, it was a reasonable one for equities. Starting with the bad news, the worst performers have been financial stocks driven lower by the collapse of Silicon Valley Bank (SVB) and wider concerns around the banking sector.

What caused SVB and Credit Suisse to collapse?

This was felt at a regional level in the US where the effectiveness of regulation has been called into question. SVB’s problems were idiosyncratic in nature with a concentrated customer base in the US tech sector. A lack of hedging left them exposed to calls on deposits they had invested in long-dated bond holdings which were sitting at losses following the bond market falls of 2022.

Silicon Valley Bank’s problems do not match perfectly to banking stresses witnessed in Europe, where Credit Suisse after shareholder, the Saudi National Bank, announced further investment would not be forthcoming sent shares into a tailspin, forcing Credit Suisse into the arms of UBS in a hastily arranged marriage of convenience.

However, this has not served as a firebreak for the rest of the sector which remains under pressure with investor nervousness perhaps driven by a once bitten, twice shy mantra when it comes to banks despite strong capital and liquidity positions which should ultimately ensure another 2008 financial crisis is avoided.

Synergy cost drive and a short-term focus helps boost Technology stocks recovery

The best performers meanwhile have been technology stocks which staged a strong recovery following the travails of 2022. Amazon, Alphabet and Microsoft all announced layoffs in an effort to curb costs and focus more on near term profitability, scaling back expansion and shelving some longer term, more speculative projects. Consumer discretionary stocks also performed well, thanks to an improved outlook for the economy.

While at times it seemed inevitable that the combination of high inflation and sharply rising interest rates would lead to a recession, falling energy costs and rising wages have, in fact, left consumers in a relatively robust position.

What does the current economic backdrop tell us?

Looking at the economic backdrop, two systems are increasingly in evidence in the world currently. They are independent but connected. One is the real economy of consumers and businesses transacting in goods and services; the other is the financial economy transacting in loans and deposits. 

The financial economy only exists to serve the real economy, even if there is a valid debate to be had over whether economies have become over financialised. The real economy remains in pretty good shape. Indeed, there are some signs of it strengthening, although these are not conclusive.  

Though recent manufacturing data pointed to a contraction in activity, the service sector appears to be gathering steam and, being so much larger than the manufacturing sector, it is difficult not to take our cue from it. Business services showed a broad improvement in services activity, and, in the UK, retail sales data showed a substantially larger expansion than had been expected. 

This was the first two consecutive months of retail sales expansion since April 2021. It likely reflected the fact that consumers are beginning to get over the shock of a year of high inflation. Generally, consumer sentiment, whilst currently being very depressed, is improving, and measures of consumers’ expectations are rising markedly.

Perhaps the most concerning economic data was UK inflation, which unexpectedly saw a rise in the year-on-year rate. Although some of the increases could be traced to quite volatile components, the traditional mechanism of stripping out food and energy prices to get core inflation offered no comfort. Core inflation rose by the largest amount, on a monthly basis, since April 1991 (which saw increases in VAT and fuel duty).

It would have seemed cavalier to not increase interest rates in the face of apparent inflationary pressure, and in advance of strong retail sales. So, the Bank of England’s Monetary Policy Committee showed resolve and raised rates by 0.25%, as the US Federal Reserve had done under similar circumstances on earlier in the week.

The case for not raising rates centred around the financial stress that continues to emanate from the banking system issues highlighted above. As ever in finance though, without being able to conduct a controlled experiment, we shall never know if the measures enacted were the right ones or if the banking jitters should have prompted a temporary cessation of the rate hiking agendas of the Fed, ECB and Bank of England.