Fabian Estevez

With the recent volatility unleashed due to the closure of Silicon Valley Bank (SVB) operations, we share a series of questions and answers with the information we have so far.  

What happened to SVB?

On March 8, SVB, based on the U.S. West Coast, announced the need to sell its US$21bn Available for Sale Securities (AFS) portfolio, which led it to acknowledge a loss of US$1.8bn. At the same time, the bank planned to raise US$2.25bn by issuing common shares and convertible preferred shares to improve its liquidity position within its balance sheet. After this statement, in hours, the bank suffered a bank run (massive withdrawal of deposits), so California regulators had to intervene in the bank. 

What is the market worried about?

Bank indices and shares of financial institutions worldwide have fallen sharply after the news of the closure of SVB, with uncertainty centering on whether this situation could be an idiosyncratic event from SVB or if there is a risk of relevant systematic transmission. At the moment, a couple of banks have been intervened, First Republic Bank and Signature Bank, also by bank runs since they maintained a high concentration in their depositors. At the time of writing, the information and the market do not point to a significant risk of contagion for this sector.

What did regulatory authorities announce over the weekend? 

At an emergency meeting, U.S. financial regulators (Treasury Department, the Fed, and the Federal Deposit Insurance Corporation) assured all depositors on Sunday that their money is safe after SVB bankruptcy. In this context, the authorities emphasized that the bank’s depositors will have access to all their money as of Monday, March 13. The statement noted that taxpayers would not be liable for any losses associated with SVB’s resolution. Similarly, the Fed announced implementing a loan program for financial institutions affected by the collapse of SVB.

How does SVB’s situation compare to other banks?

SVB had a high concentration in emerging growth companies (start-ups and venture capital) in specific niches, focusing on the technology and healthcare industries. The boom in technology fundraising and the large number of Initial Public Offerings (IPOs) in the wake of the pandemic substantially accelerated SVB deposits. As the operating conditions of these types of companies deteriorated over the past year, SVB began to experience a more pronounced than expected withdrawal in its deposits. Therefore, the deposit base that the bank had did not function like traditional commercial banking. Another factor that influenced SVB’s fall was its high exposure to low-yielding Treasury and mortgage agency securities, leaving SVB vulnerable to market losses due to the sharp increase in rates last year. 

Contrary to SVB, the largest capitalization banks that could pose greater systemic risk worldwide were subject to a broader review by their respective regulators in the wake of the pandemic and other regulatory changes over the past decade. Therefore, this type of bank has a healthy portfolio of deposits and diversification, distributed among retail, institutional, and wealth management deposits. This offers a relatively stable deposit base. They also hold significant positions in what is known as HQLA (High-quality liquid assets), usually in cash and short-lived government securities. Finally, under Basel III regulations, they operate with strict LCR (Liquidity coverage ratio). Banks must maintain this LCR ratio >100% (i.e., always have enough HQLA to fund money outflows in a 30-day stress period). 

What implications could it have on monetary policy? 

The SVB situation represents a different complexity component for the Fed’s following announcement, reflecting other consequences of tightening monetary policy. Following the Fed chairman’s aggressive stance ahead of his most recent congressional appearance, markets began pricing in a higher probability of a 50bp hike at the next meeting in March. However, these expectations subsequently fell with the news of SVB’s closing of operations, again considering an increase of 25bp and in which the FOMC (Federal Open Market Committee) members would have to prioritize financial stability for the excellent functioning of the banking system and markets. 

Conclusion

While SVB implies the most significant failure of a U.S. bank in more than a decade, and events like this can trigger instability, the risk of a crisis may be limited, especially since large, systemically important banks do not share the same vulnerabilities of which SVB was subject. In addition, regulators have already taken measures to avoid further transmission, not to mention that the Fed may rethink its policy strategy in the coming months, prioritizing the smooth functioning of the financial system.

Banks’ LCR liquidity coverage ratios (%)

Quarterly reports are nearing completion, with 95% of S&P 500 companies releasing their numbers. Against this background, we summarize the key points the season has left us.

On the one hand, earnings per share (EPS) behavior was much weaker sequentially since, in 3Q22, a growth of 4.4% was observed year over year (YoY). At the same time, the final figure indicates that, in 4Q22, EPS decreased 3% YoY (at the beginning of January, analysts estimated a 2% YoY drop). Since 3Q20, S&P 500 companies have not reported a reduction in their EPS (-5.7% YoY).

On the other hand, 68% of the sample published an EPS that exceeded consensus expectations; this compares to the long-term average of 66.3% and the average of the last four prior quarters of 75.5%.

By sector:

Energy companies drove most of the results seen at the aggregate level (excluding this sector, S&P 500 EPS would have declined 7% YoY), with earnings growth of 55% YoY.

The industrial and consumer discretionary sectors also contributed positively, recording 40% and 21% YoY increases, respectively. 

On the other hand, the materials and communication services sectors led the negative performance with drops of 29% and 28% YoY.

Another point indicates that 105 companies in the S&P 500 have issued guidance or estimate of earnings growth for 1Q23.

Of these 105 companies, 77% shared a negative guidance, and the remaining 23% gave a positive expectation. This rate of 77% is above the 5-year average of 59% and the 10-year average of 67%; the information technology, manufacturing, and consumer discretionary sectors comprise the most significant number of companies with negative expectations.

With this data, analysts anticipate that S&P 500 earnings per share could decline by 4.5% in 1Q23, so the entire 2023 growth would average around 1.5%.

Finally, the season showed that sales performance was reasonable, with an increase of almost 6% year over year , in which 59% of the sample exceeded analysts’ expectations.

The official February manufacturing activity (PMI) report in China advanced strongly and remained in the field, indicating expansion (+52.6 points*). This result was better than expected and represented its highest reading since April 2012. 

Among the report’s details, the notable rebound in the export orders component stood out, which is particularly interesting because there are concerns in the market about the possible strength of external demand. This external sector performance could have resulted from a more significant normalization of the supply chain. Similarly, the new orders component (considered an economic leading indicator) revealed significantly positive numbers, suggesting that activity could remain robust for the coming months. 

Regarding the activity of the services, the numbers were also favorable (+56.3 points), where recovery is maintained beyond the festive season of the Lunar New Year. In this sense, the non-manufacturing PMI touched its highest reading since March 2021 in February. With the mix of these figures, employment conditions could continue to improve, so there could be higher household income growth and higher domestic consumption. In this context, the consensus estimates that China’s economy could grow by 1.3% in 1Q23. 

From now on, markets will closely watch the development of China’s National People’s Congress, which begins on March 5, amid a government shakeup not seen in decades as Xi Jinping operates with greater control. In addition, the economic growth target for this year (5 – 6%) will be set, and national security issues will be addressed, including rising tensions with the United States.  

Source: CNBC – National Bureau of Statistics of China

The debate in the US Congress on extending the government’s debt ceiling will be the main fiscal issue on the markets’ radar this year. On January 19, the government reached its legal debt limit of US$31.4 trillion (an all-time maximum). Therefore, we share some points that could influence the negotiations throughout this process:

•    Date “X”: The Treasury has not set a deadline. However, it is estimated that the actual date when the government would lack the necessary resources to pay all its obligations would be between July and September (this was expressed recently by the Congressional Budget Office, CBO). The determination of the “X” date will depend mainly on the income received via taxes during April. 

•    The Republican Party has a slight majority in Congress: Republicans do not have much bargaining power because the party has its lowest majority in the House since 2001-2003.

•    Tax revenues could decline: The government continually receives income through tax collection, although the pace and magnitude of those revenues depend more on the economy. Under this context, the market assumes that the economy could grow 0.6% this year. 

•    Restrictive financial environment: With interest rates rising rapidly, financing conditions have become more challenging. Therefore, future government spending could experience a significant impact (currently, interest payments represent 8% of tax revenue).

With the prospect that the Treasury may have exhausted its resources by the summer, the most likely scenario points to an agreement among lawmakers to raise the debt limit, where possible episodes of political controversy are not ruled out. In this sense, the Republicans will not increase the debt limit in exchange for spending cuts. At the same time, the Democrats would defend an increase in the limit so as not to fall into default and avoid increased tensions such as those experienced in 2011, when the S&P cut the government’s rating from AA to AA.  

The Consumer Price Index (CPI) advanced 0.5% in January, from the 0.1% increase seen in December (the monthly figure for December was revised slightly upwards). As a result, annual inflation stood at 6.4% (vs. +6.5% in December and +6.2% estimated). Core inflation, which excludes the most volatile categories such as food and energy, accelerated by 0.4%, causing its annual variation to register a rate of 5.6% (vs. 5.7% in December and +5.5% estimated).

In detail, the shelter index was the most significant contributor to the monthly increase of all items, representing almost half of the monthly increase. This category participates in more than a third of the index, rising 0.7% monthly and 7.9% in its annual comparison. Another relevant component, food (~14% within the index), increased by 0.5% in the month (+10.1% year-on-year). The food-at-home subcategory increased by 0.4% per month and 11.3% per year, respectively. In turn, the energy component surprised (~7% of the index) by rising 2% in the month (vs. -3.1% in December), with its annual figure reaching a rate of 8.7%. Within the main subcategories, the one referring to energy commodities advanced 1.9% monthly (+2.8% annually), while energy services rose 2.1% monthly (+15.6% annually). In particular, electricity rose 0.5% monthly (+11.9% annually). On the other hand, on a positive note, medical services (~7% of the index) fell 0.7% in the month (+3% annually), airfares (~1% of the index) fell 2.1% monthly (+25.6% YoY), and used cars and trucks (~3% of the index) were down 1.9% monthly (-11.6% annually).

In this context, we believe that this inflation report produces mixed results since, on the one hand, it continues to be phrased that the disinflation process continues its course, but at a slow and gradual pace, in which significant pressures on food products and those “sticky” components like shelter. This mix of factors influencing the behavior of inflation somewhat justifies the tone and hawkish stance that Jerome Powell has expressed, as well as various members of the Fed in different spaces since the beginning of the year, including the most recent FOMC statement for February.

The official January jobs report showed the non-farm payroll increased by 517,000 jobs, well above consensus expectations of 190,000. In addition, the unemployment rate stood at 3.4%, the lowest since the late 1960s, while average weekly hours worked jumped from 34.4 to 34.7 in December. Finally, the JOLTS (job openings) also surprised to the upside, rising to 11 million in December (vs. +10.4 million in November) and jobless claims that remain low, despite recent announcements of layoffs by significant companies.

In this context, the hopes of a change of direction in the Fed’s policy have started to lose strength since the Central Bank cleared that it wants to see a better balance between supply and demand. In his press conference following the February FOMC meeting, Fed Chairman Jerome Powell described the labor market situation as extremely tight. Therefore, it will be necessary to have more evidence that this balance is being reached (debe ser has been) before considering stopping the rise in interest rates.

Reaffirming the previous idea, Jerome Powell expressed again before the Economic Club of Washington that if the job market reports remain strong or if there is a possible acceleration of inflation (referring to this point, he positively highlighted that there is a notorious reduction), “it may well be the case that more needs to be done and rates increased more than the market has anticipated.”

The Fed will exhaust all its options to bring inflation to its long-term target of 2%. However, futures for the federal funds rate continue to reflect that the peak will be reached in June, with a rate of 5% (in line with the view that was held before the end of 2022), which may be maintained, depending on economic conditions.

Unemployed workers and vacancies (figures in millions)

In its first release of the year and in line with expectations, the Fed increased the reference rate by 25bp to a range between 4.5-4.75% (the decision was unanimous), its highest level since October 2007. This decision represented a minor movement compared to the 50bp advance last December and the 4 increases of 75bp implemented throughout 2022.

The Committee anticipates continued increases in the target range will be appropriate to achieve a monetary policy stance tight enough to return inflation to 2% over time. In this sense, the Committee will consider the cumulative tightening that has been implemented (8 consecutive increases in the reference rate), the delays with which monetary policy impacts economic activity, inflation, and the evolution of financial conditions. Also, the Fed will continue to reduce its holdings of Treasury and agency debt and agency mortgage-backed securities (as described in previous communications).

On the other hand, the announcement highlighted that the latest indicators point to moderate growth in spending and production; meanwhile, the labor market’s performance has been robust in recent months, with an unemployment rate that has remained low. In terms of inflation, it highlighted that even though it has slowed down a bit, current levels remain high.

In his conference, Jerome Powell ratified that it is necessary to maintain a restrictive position for a while to restore stability in inflation. At the same time, he emphasized that the labor market operates under highly tight conditions. Finally, he communicated that it is gratifying to see a disinflationary process underway.

Expectations for the Reference rate

Against a backdrop of rapidly rising US interest rates and mounting recession fears, most currencies weakened significantly against the US dollar in 2022. However, the Mexican peso was one of the outliers, appreciating 5% in 2022 and now trading below 19 per US dollar, a level not seen since February 2020, with a 3.6% gain this year.

What can explain this appreciation? The peso was highly exposed to global risk sentiment and liquidity conditions in 2022, but according to analysts, four idiosyncratic factors more than offset this reality. As we enter 2023, these factors will continue supporting the peso, particularly during the year’s first half.

 1. Interest rate differentials: Banxico began raising the reference rate in June 2021 to cushion the impact of the Fed’s rate hike. After a 650 bps (6.5 pp) rise, it is expected that Banxico is close to the end of the hiking cycle. However, the rate differential is expected to hold.

2. Positive impact of a relatively resilient US economy: The strength of the US economy in 2022 increased demand for manufacturing exports and boosted remittances from the US to Mexico to record levels. The slowdown of the ‘northern neighbor’ that we expect in 2023 should moderate remittances and the growth of manufacturing exports from very high levels.

3. Stable fiscal position and robust institutional framework relative to peers: Mexico’s credit outlook compares favorably with most of its Latin American peers, given its fiscal stance. Mexico faces several medium-term fiscal challenges, although these will likely be on investors’ minds this year, as its fiscal accounts remain strong relative to most emerging countries.

4. Constructive narrative of nearshoring: Mexico benefits from nearshoring as US companies try bringing production closer to home. According to estimates by the Inter-American Development Bank, Mexico could generate US$35bn per year in additional revenue from exports of goods through nearshoring in the coming years. While it may be too soon to assess the impact of this phenomenon on Mexico’s long-term growth, we believe it offers a positive narrative in investors’ minds.

As for the risks it faces, the possible consequences of a trade dispute with the United States and Canada stand out in the context of alleged violations of the USMCA in energy matters, which must be monitored. Also, a deterioration in investor confidence in the face of a larger-than-expected US recession could significantly damage the Mexican economy.

Reference rate trajectory (%) in Mexico and the United States post-pandemic

Like every year, Blackstone, one of the largest alternative investments manager with over $951 bn assets under management, published its 38th edition for their Ten Surprises for the year.

Blackstone defines a Surprise as an event in which the average professional investor would assign a one-third chance of taking place, but which the asset manager believe has a 50% or better chance of happening.

1.    Multiple candidates on both sides of the aisle organize campaigns to secure their party’s presidential nomination. There are new headliner names on the respective tickets for 2024.

2.    The Federal Reserve remains in a tug-of-war with inflation, so it puts the word “pivot” on the shelf alongside the word “transitory.” The fed funds rate moves above the Personal Consumption Expenditures price index (PCE; 4.7% for November) and real interest rates turn positive, a rare phenomenon relative to the last decade, but appealing for fixed income assets.

3.    While the Fed is successful in dampening inflation, it over-stays its time in restrictive territory. Margins are squeezed in a mild recession.

4.    Despite Fed tightening, the market reaches a bottom by mid-year and begins a recovery comparable to 2009.

5.    Every significant correction in the market has in the past been accompanied by a financial “accident.” Cryptocurrencies had a major correction and that proved not to be a systemic event. This time, Modern Monetary Theory is fully discredited because deficits have proven to be inflationary.

6.    The Fed remains more hawkish than other central banks, and the US dollar stays strong against major currency pairs, including the yen and euro. This creates a generational opportunity for dollar-based investors to invest in Japanese and European assets.

7.    China edges toward its growth objective of 5.5% and works aggressively to re-establish strong trade relationships with the West, with positive implications for real assets and commodities.

8.    The US becomes the largest producer of oil. The price of oil drops primarily as a result of a global recession, but also because of increased hydraulic fracking and greater production from the Middle East and Venezuela. The price of WTI touches $50 this year, but there’s a $100 tick out there sometime beyond 2023 as the world recovers.

9.    The Russian invasion of Ukraine continue for the first half of 2023. In the second half, the combination of humanitarian and economic costs on both sides derives in a ceasefire and negotiations on a territorial split begin.

10.    In spite of the reluctance of advertisers to continue supporting the site and the skepticism of stakeholders about the firm’s credit quality, Elon Musk gets Twitter back on the path to recovery by the end of the year.

It is important to mention that this weekly commentary is for informational purposes and does not reflect an investment recommendation by our Investment Committee.

The quarterly reporting season of 4Q22 is about to begin, being a factor that could influence the mood of the markets in the concise term. In this sense, analysts estimate that the S&P 500 companies would have experienced a 4.1% year-on-year contraction in their profits. If this figure is confirmed, it will mark the first time the index has reported a fall in earnings since Q320 (-5.7% YoY). Concerning revenues, prospects point to growth of 3.8% (YoY), representing a considerable adjustment compared to the 6.3% growth projected at the beginning of 4Q22.

Given the lingering concerns in the market about a possible recession, the following question emerges: would analysts have adjusted their expectations for the recently concluded quarter more than usual? The answer is yes. Throughout 4Q22, analysts cut their earnings per share (EPS) estimates by a higher-than-average margin, resulting in a downward revision of ~7%. This number exceeds historical statistics, which indicate that over the last 10 (40 quarters) and 15 years (60 quarters), the average downward revisions were 3.3% and 4.8%, respectively. If we extend the analysis period to the last 20 years (80 quarters), an average decrease of 3.8% is observed. At the industry level, nine of the eleven sectors would have followed a negative revision in their EPS, led by the Materials sector (-18.8% YoY), Consumption Discretional (-13.5% YoY) and Communication Services (-11.8% YoY). In contrast, only Energy and Utilities sectors witnessed a positive revision of 2% for each. 

In this context, full-year 2022 profits would have advanced 4.7% YoY. On the other hand, the current estimate indicates that profits could rise by 4.8% year-on-year in 2023. However, this figure may be revised downwards depending on economic conditions.

Finally, we highlight that the season’s core point will be presented between the last week of January and the first half of February.