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CA-EN Advisors
THIS WEEK WITH SADIQ

The Volatility Wild Card

March 20 to 24, 2023

THIS WEEK WITH SADIQ

The Volatility Wild Card

March 20 to 24, 2023

Weekly Commentary

Market Recap

  • Equity markets endured a volatile week amid ongoing trouble in the bank sector.
  • The S&P 500 finished up 1.4%, as sharp rallies in technology and telecom services outweighed another slide in financials.
  • Lower bond yields fueled higher-beta stocks despite trouble elsewhere. The TSX, however, was down 2% as banks and energy weighed heavier.

Wild Card

If recent weeks have shown us anything, it’s the importance of having a well-diversified portfolio to mitigate downside risks. Banking is considered a relatively safe sector—yet, even there, investors needed diverse exposure to North American financials to better insulate themselves from the implosion of Silicon Valley Bank (SVB). (And, subsequently, First Republic and Signature Bank). The question now is, how far will the contagion reach? We believe investors should view SVB as an outlier because of its concentration in certain niches, such as startups and crypto-oriented firms, which make the bank uniquely vulnerable to deposit pressure. Also, U.S. regulators stepped in to backstop uninsured deposits, meaning even accounts holding more than $250k in cash will receive full restitution. But there are downsides to intervention. If the government shores up uninsured deposits, the distinction between a quality and non-quality bank diminishes because both become equally secure. For now, however, risks will persist as the fallout of SVB plays out over the next two to three months.

Bottom Line: In the near term, a cloud hangs over the banking sector.

Knock-on Effects

What aftershocks will SVB’s failure have on interest rates, bank regulation, and overall investor sentiment? For regional banks, particularly those in the regulatory no-man’s-land of $50 billion and $150 billion, we could see heightened scrutiny and pressure to temporarily freeze dividend payments. That may cause hurt to regionals—however, these actions are unlikely to affect larger financial institutions because they are generally well capitalized and more closely monitored than their smaller counterparts. As for interest rates, the U.S. Federal Reserve is unlikely to be deterred from its current path, though perhaps the size and sequence may evolve based on the SVB fallout. For instance, we continue to expect a 25 basis-point hike at the next meeting on March 22, which was our base case prior to the recent banking woes. We also find it hard to believe the central bank will stop there—it’s unlikely that they will be one and done with rate hikes, especially if inflation continues to remain sticky. All that said, could they pause at the next meeting? Possibly. Our overall expectation is for higher risk-off sentiment in the near term, which could inadvertently deliver the economic ‘pain’ needed for the Fed to downshift their policy actions.

Bottom Line: We have taken 2-3% off our equity position to accommodate for the rise in market volatility in the short term.

Under the Radar

Though negativity continues to dominate headlines, investors may be underappreciating two key points of interest. First, SVB’s concentration in tech startups could mean the market becomes more selective in that space, with greater separation between the proven venture capital (VC) firms and those with less experience. In other words, investors looking to access private markets should ideally focus on the quality of the manager they choose. Meanwhile, on the Energy front, we’ve seen huge pullbacks that are largely unjustified. Markets have moved to a risk-off sentiment en masse, and Energy is the baby being thrown out with the bath water. We will continue to hold our long position on U.S. energy equities—that said, as we wait for a broad-based rally in the sector, we will also continue writing call options to generate greater income from the volatility

Bottom Line: Private market investors must be deliberate about manager selection while Energy investors need only stay invested.

Positioning

Many of the events related to SVB and the recent banking chaos happened just after our monthly views were finalized. However, we adapted quickly by taking some equity risk off the table and incorporating new data into our forecasts for earnings, interest rates, and more. Get the detailed breakdown of our portfolio positioning in the latest BMO GAM House View Report, titled Banking and Bad Apples: The Aftermath of SVB.

Disclosures:

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.


BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.


Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.


This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.


Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.


For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.


BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.


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