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Our views 14 March 2023

The SVB failure: Lehman or LDI?

5 min read

The failure of Silicon Valley Bank shocked markets, causing stocks to drop and government bonds to rally sharply as investors questioned the soundness of smaller banks and factored in a possible pause in Federal Reserve (Fed) tightening.

The key question is whether this marks the start of a problem that will take months or years to work through, as with the Global Financial Crisis. Alternatively, is it a short-term event triggered by bond portfolio losses, like the UK’s Liability Driven Investment (LDI) turmoil last year, that can be dealt with primarily via central bank liquidity injections?

The pessimistic interpretation is that monetary tightening works with a lag and bank failures could set off a credit crunch that tips the US economy into recession. We have great sympathy with this view as we do expect rate hikes to lead, in the end, to a rise in unemployment and a second phase of stock market weakness (see chart).

However, the specifics of the SVB situation make us doubt this is the moment to shift portfolios wholesale into government bonds. In recent months the US economy has been picking up steam and SVB’s problems were not in its loan book. Rather, it was suffering from losses on the bond portfolio it built up to back the out-sized deposits it took from tech companies during the pandemic. Deposit flight made this problem acute.

The US authorities have acted quickly to guarantee deposits and to allow banks with similar issues to access central bank liquidity as if their bond portfolios were valued at par. If they succeed in stemming deposit flight from small banks, then market volatility may be short-lived, as we saw when the Bank of England successfully intervened to end the LDI crisis.

We have been overweight stocks in our multi asset funds since last September with exposure tilted towards European markets, which has been painful in recent days. We have taken action to reduce risk in the portfolios and we are monitoring the situation closely, ready to either get more defensive – or buy the dip – as the economic impact of recent events becomes clearer.

Chart: Global stocks usually underperform bonds when unemployment rises

Chart shows stocks vs bonds compared to the US unemployment rate which has been inverted

Past performance is not a guide to future performance. The views expressed are the author’s own and do not constitute investment advice. Source: Refinitiv Datastream as at 13/03/2023.


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.