Investment Climate April 2023: The Fed, Banks and Business

In the first quarter of 2023, markets continued the wildly volatile ride that they have been on for some time now, ending the quarter up mid to high single digits across most major indices. Our portfolios for both Core Growth and Income Strategies ended the quarter similarly. But, as suggested, the path to that end was anything but sanguine given that six weeks into the quarter, portfolios were up over 20%, only to give back most of those gains by mid-March, and then to gain back most of the overall quarterly gain in the last few days of the quarter. Simply crazy! But it is the hand we have been dealt in this era. Once again, it was fear of the Fed’s fight against the economy (oops! sorry, inflation) that sent stocks back down mid-quarter, and the hint of a possible end to this battle which rallied stocks back in the last days of the quarter. We highlight the Fed’s fight against the economy simply to emphasize that officials at the Fed believe that economic growth, in the form of employment, causes inflation, instead of the simple truth that it is the spending by government and ensuing money creation from the Fed that is the ingredient for inflation. It’s simply “too much money chasing too few goods” that causes this monetary phenomenon called inflation, not that too many people are employed! But we have said this so many times over the years that we are weary. And we are certainly not alone. Far smarter people than us, like Milton Friedman, have said the same thing, to no avail. But we are compelled to continue to point that out. Who are we -- or who is Milton Friedman -- to contradict the institution that has presided over a more than 90% drop in the purchasing power of the dollar since its inception in 1913! Reminder, the Fed’s dual mandate is “full employment” (whatever that is) AND a “stable currency”. How’s that working out? But we digress. Earnings expectations and guidance from companies have certainly come down. Overall market earnings are expected to decline in the first quarter in the overall market. Given the headwinds created by the Fed, this is not surprising. And yet, as we have pointed out in previous commentary, podcasts and blogposts, we continue to be amazed and impressed at the way our portfolio company management teams are handling this environment, where so much seems stacked against them. Over time we have every confidence that they will reach their objectives and visions for their companies. But the focus these days is so short-term oriented, it is often impossible to see past the nonsense of the Fed, bad policy and a void in leadership everywhere to get to the real objective of finding successful businesses. We intend to stay focused on that objective, regardless of what the day-trading world (which is most of the investment world today) thinks is important. No interest rate cycle, market cycle, economic cycle, nor political cycle will deter us from that focus. Lastly, as for the bank failures. Our view is that of the three bank failures, two (Silvergate and Signature) were deliberate attempts on the part of regulators to destroy the “on and off ramps” of fiat currency (the Dollar) to/from crypto currency, as a means to ultimately destroy the crypto ecosystem. In the case of Silvergate (which we owned until this reality became clear a few weeks before the failure), we do not believe the bank did anything wrong. Between the short-sellers and an aggressive regulatory regime, it was impossible for them to stave off the “run”. As for Signature, it is less clear, but we suspect something similar happened. As it relates to Silicon Valley Bank (SVB), this one is very interesting, and we think may have a silver lining. Besides being caught in the “borrow short and lend long” conundrum that banks often grapple with when rates are rising aggressively and their bond portfolios are dropping in value, we think there is more at work here. SVB was “ground zero” for the venture capital heavyweights who benefitted greatly from the “free money”, zero percent interest rate regime that the Fed engineered in the wake of the 2008-2009 financial crisis. We wrote extensively about the dangers of such a policy for the almost 15 years it had existed. We believe that environment resulted in an unprecedented amount of malinvestment in the Silicon Valley ecosystem which allowed easy money to fuel money-losing projects for too long, and starved capital from real, core technology that was just too complicated for many of the 21st Century VCs to understand or take the time to learn. It drove an unsustainable “binge” of excess in Silicon Valley that was exemplified in the way SVB was run. The unwinding of this, and maybe the zero percent interest rate strategy, may have positive implications for the allocation of capital going forward. Regardless, as we always end up saying, well-run businesses will find a way through to the other side of this mess that has been self-inflicted. While painful to witness, in many ways, these failures will pave the way to better policies and circumstances. There is no alternative. Stay tuned to our podcasts, blogs, and this commentary, all found at www.taylorfrigon.com, for more as we manage through this era in investing.