Investor Education: Bear Markets
A bear market is a period of declining stock prices that can last several months to a few years. Bear markets are usually defined as a drop of more than 20% from the recent high in the indices (S&P 500, Dow 30, Nasdaq, etc.).
Read our overview of Bear Markets here
A Week When Something Happened
“There are decades where nothing happens; and there are weeks where decades happen.” —Vladimir Ilyich Lenin
Silicon Valley Bank became the second-largest bank to fail in U.S. history this past week, trailing only Washington Mutual in 2008. While its asset-liability mismatch had been public and known about for some time, the collapse basically happened in 48 hours.
Stock markets didn’t exactly like the news. The S&P 500 and the Nasdaq both fell over 4.5% on the week.
What happened? And what might happen next?
Silicon Valley Bank was one of the main banks used by start-up technology companies. It gained that reputation over decades and, as the technology industry grew and grew, often aided by cheap money, so, too, did Silicon Valley Bank.
With all the money flowing into technology companies from venture capitalists and other investors over the last decade or so, the bank had a problem putting those deposits to productive use by making loans, and so it did other things. To recap what those things were, we turn to Matt Levine’s excellent summary at Bloomberg:
Or, to put it in different crude terms, in traditional banking, you make your money in part by taking credit risk: You get to know your customers, you try to get good at knowing which of them will be able to pay back loans, and then you make loans to those good customers. In the Bank of Startups, in 2021, you couldn’t really make money by taking credit risk: Your customers just didn’t need enough credit to give you the credit risk that you needed to make money on all those deposits. So you had to make your money by taking interest-rate risk: Instead of making loans to risky corporate borrowers, you bought long-term bonds backed by the US government.
The result of this is that, as the Bank of Startups, you were unusually exposed to interest-rate risk. Most banks, when interest rates go up, have to pay more interest on deposits, but get paid more interest on their loans, and end up profiting from rising interest rates. But you, as the Bank of Startups, own a lot of long-duration bonds, and their market value goes down as rates go up.
On top of that problem, the environment during the last couple of years has made it harder for money-losing technology companies to raise equity capital. So those companies didn’t deposit new money, and instead took out the deposits they already had to cover operating losses. That created some natural deposit outflow, which was then dwarfed by the bank run this past week, which was created in large part by venture capitalists advising those money-losing companies to pull their money out of the bank.
What happens next? It’s hard to say, and anything we write might be out-of-date by the time it’s published.
Banks stocks sold off sharply at the end of last week, showing there are growing fears this could lead to further contagion. And given the government’s involvement in the financial markets in seemingly every crisis post-Lehman in 2008, the guess we will make is that we’ll see plenty of attempts—and maybe even a drastic move—by government officials to calm the fears that this is the first domino in a larger crisis.
And we’ll make one more guess. In 2008, companies were eager to get an investment from Warren Buffett and Berkshire Hathaway to ease the collective minds of stock and bond investors. We hypothesize that Mr. Buffett’s phone has once again had a busy weekend. With every crisis, there is an opportunity for someone.
“The traditional debate is between those who believe that the government should not intervene to save firms that are financially challenged; those who advance this view believe that if asset prices decline sufficiently sharply, the markets eventually will stabilize and investors who had been waiting on the sidelines will then buy the institutions that had lost most of their capital. Those who support this view subscribe to the moral hazard position that the next financial crisis will be more severe because the lenders would believe that they will be bailed out. The challenge to this view is that each of these crises is different, and that the economic costs of not stabilizing the system are severe.” —Charles P. Kindleberger and Robert Z. Aliber (“Manias, Panics and Crashes: A History of Financial Crises”)
Tweets of the Week
Golf Society 319 - Tournament at the Dormie Club in Pinehurst
319 Golf Society is taking over the Dormie Club’s campus for our first Spring Invitational! ⛳️ This opportunity to go on an exclusive golf getaway is one you don't want to pass up! Share this amazing opportunity with your golf buddies so you can Swing into Spring with three days of fantastic food, company, and competition!
Click here to learn more about Golf Society 319!
Tiktok failed to load.Enable 3rd party cookies or use another browser
Fresh Vine Wine
Actresses Julianne Hough and Nina Dobrev recognized the importance of balancing an active lifestyle and still enjoying delicious wine. Together, they co-founded Fresh Vine Wine, premium quality wines that embody a deeper connection with a healthy lifestyle.
Produced and bottled in Napa, California, the Fresh Vine Wine collection features a California Cabernet Sauvignon, Pinot Noir, Chardonnay, California Rosé Wine, and a Limited Reserve Napa Cabernet. All of these unique wines use a proprietary and natural winemaking process.
Use Code: SOCIAL20 for 20% off your order! www.freshvinewine.com
Low Calorie . Low Carb . Low Sugar . Gluten Free . Premium Wines
In Case You Missed it…
Shifts in the Economy are Triggering a Shake-Up in Real Assets
Psychological Paths of Least Resistance - by Morgan Housel
Good Investing Talks video: Guy Spier — A talk about honesty, givers, and meditation
2022 Fairfax Letter Highlights
WeathTrack Podcast: Small-Cap Stocks with Short-Term Problems: The Secret to Beating the Market
Forward Guidance Podcast: Chris Whalen: The Fed Is To Blame For The Collapse of Silicon Valley Bank
Founders Podcast: #293 The Making of McDonald's: The Autobiography of Ray Kroc
If you have not already upgraded your membership…
Avenel Financial Group, a merchant banking and advisory firm located in Charlotte, NC, launched a new business venture called the Co/Investor Club. The Co/Investor Club is a community of value-oriented investors that collaborate on investment opportunities and ideas. You are receiving this newsletter because you are a Free or Premium Member of the Co/Investor Club!
Chat with Mike
Whether you’re an executive with investment opportunities or a college student looking to network, we would love to chat with you! Email our Founder, Mike Pruitt, at mp@coinvestorclub.com with questions and ideas or schedule a meeting.
Don’t forget to follow us on social media too!
Twitter: @coinvestorclub1
LinkedIn: Co/Investor Club
For our disclaimer, please visit our website.
Have friends that want to join? The Co/Report is public, so feel free to share!
Thank you for reading. Co/Report grows through word of mouth. Please consider sharing this post with someone who might appreciate it.
