SustainAbility: Back to the Future

‘Back to the Future’ was a film released in 1985, with my namesake Michael J. Fox playing the role of Marty McFly, who was unfortunately transported back in time by a DeLorean car-based time machine.

Stranded in the past, he had to find a way to get back to the future. It was a very successful film with two sequels, and the likable actor who starred in it became an inspiration for many after he began to suffer from Parkinson’s disease and campaigned to raise awareness.

In the last two weeks it felt like investors have been transported back in time to 2008 when the global financial crisis was at its peak, and are trying to get back to a time when the banking system was secure.

The failure of the little-known US Bank, Silicon Valley Bank (SVB) has been quickly followed by the rescue of Credit Suisse by UBS and the Swiss government. We have no exposure, equity or debt, to these companies in our sustainable funds but recent events may have broader implications.

First, let’s be clear: this isn’t 2008. There were systemic issues back then that do not exist now. These include pervasive excessive risk-taking in the banking system, weak regulation, bad loans linked to housing, no visibility as to which bank owned which assets, and no plan in place for how to react if a bank did get into trouble. Today banks are, overall, much stronger financially, with lower risk loan books and stronger regulation. This is not to say that all banks are well managed – like any industry there will be failures – but the overall health of the industry is much better today.

Indeed, one more positive aspect of recent events is how quickly both SVB and Credit Suisse were resolved. What took months in the financial crisis of 2008 took days. A systemically important bank, Credit Suisse, became financially troubled and needed to be rescued, and it was completed with no broader damage done. This is a huge change.

There are still lessons to be learnt, however. In the US, smaller regional banks have not been as tightly regulated as the big banks, and this will likely change. The negative impact of rising interest rates on the assets owned by banks will also be a focus going forward. Most sensible banks (including the ones we invest in) have hedged this risk, making rising rates much less detrimental. Indeed, many were required to do this by regulation. The overall lesson though is that interest rate increases have put strain on the financial system.

What are the banks saying?

Coincidentally, and helpfully, we met with the CEO of one of the major UK banks last week, and this week with the CFO of another. These meetings were pre-planned but did give us an opportunity to hear how they viewed recent events.

SVB and Credit Suisse were viewed as two distinct issues, with the former taking undue risk that regulation had not responded to, and the latter having struggled for profitability in one of its key businesses for many years. Regulation is much tighter in the UK and Europe, making an SVB situation unlikely; while the area of Credit Suisse which was particularly problematic, investment banking, was not relevant for the companies we met.

Both banks we spoke to articulated well the social and economic value of banks, as well as their ability to make their customers and broader society prosper whilst supporting a broader sustainability agenda and making good financial returns.

Overall, and despite being attentive to the issues and risks raised, neither bank saw a direct impact to their businesses due to recent events. To some extent investment markets have agreed, with share prices recovering most of their losses of recent days.

What are the broader implications?

There are broader implications of the events of the last two weeks. Stress in the banking system will make some lenders inherently more risk-averse and that could lead to a contraction in lending. This would act as a drag on economic growth, which could be helpful regarding the future path of inflation but would impact markets such as property.

The decisions central banks need to make on the future path of interest rates have become even more complex. Continue raising rates to fight inflation and there will be criticism that financial stability is being put at risk. Cut rates and controlling inflation could become more difficult. The case for a wait and see approach, leaving rates where they are to see how the coming months unfold, is a strong one but the chances of a policy mistake due to the complexity of the situation are high.

On a more positive note, recent concerns over stresses in the economy and the outlook for growth have resulted in bonds acting as a hedge against equity exposure again. This was lost in 2022, when both equity and debt fell in value. This itself was a consequence of inflation being a negative for both asset classes, at least in the short term. If inflation becomes less of a concern, and interest rates are reduced as markets currently expect in response to an economic slowdown, bonds should perform better.

The big picture

One of the challenges in investing is seeing the proverbial wood for the trees. Events happen fast and their importance is hard to judge in the moment. Brexit, trade wars, a pandemic and a war in Europe did indeed change investment markets, but more subtly and often differently to initial thinking. Recent events in the banking sector are the next issue on this long list.

To us, the big picture is that on 1 January 2022 the investment environment structurally changed. It was at this point it became clear that the era of low interest rates and inflation, which were prevalent in the 2010s, had ended. For how long we do not know. What started as short-term concerns around supply chain bottle necks, became longer-term concerns over labour availability, energy costs and the rising cost of capital as interest rates moved higher. The consequences of this regime shift are still working through society and asset markets.

Definitions of bear markets vary, and at times in the last 15 months they have been met and at others not so. Regardless though, we do think the start of last year may have marked the beginning of a bear market in asset prices after many years of strong gains, the length and scale of which we will only know in hindsight.

The last two bear markets preceding this one were quite different. After the technology bust of 1999, a grinding three-year bear market ensued. The bear market following the financial crisis of 2008 was much quicker, at 17 months, but just as severe with respect to changes in asset prices. The last 15 months has felt more like the grinding bear market of the early 2000s, but how long that comparison goes on for remains to be seen (bear markets end as unexpectedly as they begin).

Bear markets are a natural part of investing. They are the price of being a long-term investor and for those willing to look through them, provide more opportunities than they do difficulties. Most of the best investments made are done in bear markets when sentiment often overrules fundamentals. Although current markets may feel downbeat, it will pass. In the meantime, we continue to own high quality businesses and are keeping an eye open for the inevitable opportunities which will come along.

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.