January’s strong start for stock markets was overturned in March by the banking turmoil in the US. Fears that the failure of Silicon Valley Bank (SVB) might spread through the US banking system spooked stock markets as investors feared that it might be a bigger problem. However, the US Federal Reserve’s actions to stabilize US banks and the Swiss National Bank’s orchestration of a deal for UBS to buy Credit Swiss seem to have calmed investors’ fears.
Stock markets finished the first quarter in surprisingly decent shape:
- Short Bonds and the Bond Universe Indexes in Canada: 1.8% and 3.2% respectively
- Canadian and Global REITs: 4.3% and 1.5% respectively
- Canadian Equity: 4.6%
- US Equity (in CAD): 7.1%
- International Equity (in CAD): 8.3%
- Emerging Markets (in CAD): 3.9%
PWL portfolios are up between 3% and 6%, net of fees, for the first 3 months of 2023.
Stock markets and financial journalists have turned their attention to the impact of these banks’ newfound risk aversion on the overall economy. If these banks are busy repairing their balance sheets (with the Fed’s help), are they likely to lend less and therefore have a dampening effect on economic growth? We’ll have to wait a few more months to see how that shows up in the economy, but the worst fears of mid- March have abated.
The 1980s Savings & Loan Crisis
The challenges that SVB and others like it ran into are echoes of the Savings & Loan Crisis in the late ‘80s. A combination of rising short-term interest rates and looser regulations led to the failure of about one third of the savings and loan institutions in the US at the time. These institutions took in deposits from clients and lent out funds for mortgages and car and other personal loans. When interest rates rose, the interest they had to pay to their depositors rose much faster than the interest they were collecting on the loans they had issued. This is essentially the same issue that got SVB into so much trouble, except that SVB primary loaned their depositors’ money to the US government as opposed to individuals and corporations.
The lessons from the 1980’s Savings & Loan crisis have been well applied today. The Federal Reserve stepped in quickly and took significant steps to support mid-sized US banks. Most notably, the Fed is taking government bonds off these banks’ balance sheets and replacing them with cash for the full-face value of the bonds. The Fed is essentially absorbing the losses these banks took on their bond portfolios. It can do this because it doesn’t have to sell these bonds to issue more cash, while banks would otherwise have to. The Fed can simply hold these bonds to maturity and recover the losses over time.
2023 Quebec & Federal Budgets
I would be remiss to close this update without saying a few words about the recent Quebec and Federal budgets.
The Quebec budget has continued Legault’s policy of handing out money to a much broader swath of the population than needed. From a fiscal policy perspective, this is hardly helpful in the fight against inflation. Reducing the tax rate by 1% on the first two tax brackets for Quebeckers will result in up to $814 in tax savings for individuals that earn at least $98,500. The Federal budget was more targeted in its support by raising the GST credit for lower income individuals. This credit phases out completely for those earning about $50K or more.
The Federal budget has revamped the Alternative Minimum Tax calculation, which is now targeted at Canadians who earn more than $173K per year. The Alternative Minimum Tax calculation exists to ensure that those with higher incomes pay at least a minimum amount of tax, regardless of how many deductions and credits they may have. This calculation is complicated, so it is very difficult to determine who among the high earners will be affected without an in depth look at individual tax returns.
Interestingly, both budgets seem to prioritise making it easier to file tax returns, by investing more in the digital tools available to do so (Quebec) or by automating the tax return process for low-income individuals (Federal). Both initiatives speak to a broader problem that our provincial and Federal governments have: The tax code has become so complex that it is difficult for individuals to file their own tax returns. Hopefully these initiatives are a step in the right direction, though I would much prefer to see the tax code dramatically simplified. Every new budget seems only to make the tax code more complex.
Finally, both budgets give a nod to deficit reduction and debt repayment, but both are extending the terms over which these objectives will be met relative to prior budgets. Though I don’t consider these budgets profligate, they are hardly austere.
I hope the explanations above have been helpful and as always, don’t hesitate to reach out if you have any questions or would like to discuss.
Source : PWL Market Stats