It was a well-worn phrase as the 2007-2008 financial crisis unfolded: “What will be the next shoe to drop?”
At the time, there were lots of shoes: Bear Stearns. Countrywide Financial. IndyMac. The Freddie Mac and Fannie Mae government takeovers. AIG. Washington Mutual.
(In case you’re wondering, as I was, where “waiting for the other shoe to drop” originates, look no further than the tenements of NYC).
No one is suggesting that the seizures of Silicon Valley Bank and Signature Bank are directly akin to the Great Financial Crisis. But it seems likely that the troubles of those two banks will find echoes elsewhere, and investors scrambled back and forth Monday, trying to assess where the next risk will emerge.
One of the spots they seemed to pinpoint was regional banks, whose shares plummeted, particularly First Republic Bank (FRC), even after that institution secured additional liquidity from the Federal Reserve and JPMorgan. Sellers ignored that news.
Some strategists were looking for less obvious sources of stress in the system.
“The risk is not in what you can see, it is in what you cannot see,” wrote Tony Dwyer, Canaccord Genuity’s Head of the U.S. Macro Group and Chief Market Strategist, in a note to investors. He’s advising clients to look to private markets for the next area of exposure: “We believe an additional intermediate-term risk is the impact of when investors revalue their private equity and venture portfolios to reflect less investment and a recessionary environment.”
JPMorgan strategists went further, drawing attention to all implicit or explicit carry trades. A carry trade involves borrowing at a low interest rate and investing in an asset with (ideally) a higher rate of return.
“Carry trades develop during a period of cheap financing such as the one we had over the previous decade and in particular during the post-COVID QE,” wrote the JPMorgan team, led by Chief Market Strategist Marko Kolanovic.
He put a host of assets and investments into that category, including commercial real estate; private equity; venture capital; and auto loans, levered loans and credit cards. As rates climb, assets that looked attractive when rates were low are a no-go, in Kolanovic’s view.
All of this said, there isn’t necessarily another big shoe to drop in terms of an individual bank blowup or systemic market vulnerability. There could be failures that occur at the margins without triggering a broader downturn.
It could also potentially mean a more sustained period of risk aversion, as evidenced by investors’ flight on Monday to classically defensive areas like real estate (XLRE) and utility stocks (XLU), and gold (GC=F) (and to much less classic ones, like Bitcoin (BTC-USD).
One wild card, as ever, is the Federal Reserve. Tuesday morning brings fresh inflation data in the form of the Consumer Price Index for February. Economists spent the weekend trying to game out what the SVB collapse will mean for the path of interest rate increases. Expect that game to change once again – the Fed is, of course, data dependent – and a fresh wave of interest-rate probability volatility.
That is, unless and until, another shoe drops.
What to Watch Today
Economy
- Consumer Price Index, year-over-year, February (+6% expected vs. +6.4% in January)
- Consumer Price Index, month-over-month, February (+0.4% expected vs. +0.5% in January)
- "Core" CPI, year-over-year, February (+5.5% expected vs. 5.6% in January)
- "Core" CPI, month-over-month, February (+0.4% expected vs. +0.4% in January)
Earnings
- Lennar (LEN); Guess (GES); SentinelOne (S); StoneCo (STNE)
