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04/02/2023
Dear Clients,
There are certainly quite a few moving parts to the financial markets. Banking concerns, Federal Reserve Bank (Fed) interest rate hikes, inflationary pressures, and geo-political events. Just to name a few.
If an investor were to zero in on something that seems to have its tentacles in most of these issues, my guess would be liquidity and how it affects our economy. Liquidity is a double-edged sword. Too much, we get unchecked risk. Too little, results in a potential recession. When the Fed raises interest rates, and rather quickly, it serves the purpose of slowing down growth in the economy. When rates go higher, banks loan less, individuals and companies finance less, people pay more of their discretionary income to interest, and, the all-important consumer confidence index heads south. Essentially, the Fed is pulling liquidity out of the system to moderate it. It is important to emphasize that the world’s economic progress is always a direct function of liquidity. The more money in the system, the more potential for growth. The more risk taken, the more people are employed, the more consumers spend. Additionally, it should be noted, that the Fed has a parallel plan to decrease their balance sheet by selling their fixed income securities. Again, another tool to take dollars out of play.
The recent banking (mini) crisis can be linked to liquidity as well. The few banks that have come under recent pressure did not risk manage their balance sheets very well, and that is an understatement. These banks overbought long dated bonds that have come under severe pricing pressure as a direct result of the path of interest rates. They got greedy and chased higher yields at exactly the wrong time. Simply stated, when rates rise the value of bonds decline. This repricing must be marked to market on banks’ balance sheets. Even though the bonds are high quality and not in any worry of default, their prices must reflect current market value. Given the rapid rise in rates, a bond could be written down by as much as 30%-40%. Banks have capital and liquidity requirements that must be met. Layer in our brave new world of social media, and we have a run on a bank that cannot meet its short-term obligations.
Even international events, like the war in Ukraine, have a relationship to liquidity. The US and its allies have taken extraordinary steps to damage Russia’s economy by placing numerous sanctions on it to extract liquidity out of their system and strangle any growth.
Where do we go from here? The good news is that the Fed should be nearing the end of their tightening cycle, the banking concerns are limited to those institutions that did not mind their manners, and that our economy, although slowing, seems to be holding up quite well. Oh yeah, and the S&P 500 index was up 7.5% in the first quarter.
Enjoy spring. It only comes but once a year.
All the best,
Jim
James K. Tonrey, Jr.
Partner/Chief Executive Officer
STILLWATER INVESTMENT MANAGEMENT, LLC
423 South Main Street, Suite E1
Stillwater, MN 55082
651.275.9380/877.275.9380 (Main)
651.275.9381 (Fax)
info@stillwaterinvest.com
