Time to hunker down as SVB Financial exposes growing number of naked swimmers

On Thursday, some fears of financial contagion crept into the market. SVB Financial Group (SIVB) fell 60% on the day of trading and fell sharply again on Friday.

SIVB is the parent company of Silicon Valley Bank, which is an important part of the San Francisco area’s venture capital and start-up ecosystem. The company surprised investors by selling almost all of its available-for-sale securities (AFS), which would trigger a $1.3 billion loss for the company. SVB also announced a large planned capital increase to strengthen its liquidity.

The reason the bank is doing this is because the leadership believes interest rates are likely to stay higher for longer than their previous forecast. Of course, if this view turns out to be correct, it will create a huge headwind for the banking industry. Unsurprisingly, banks were one of the weakest parts of the market on Thursday, as the S&P 500 fell nearly 2% on the day. JP Morgan Chase (JPM) is down nearly 5 1/2% and Wells Fargo (WFC) is down just over 6% during the day.

The news appears to have sparked a run on Silicon Valley Bank as venture capital firms withdraw their deposits. The stock is below $40 a share in early trading. As a measure of how quickly things can go downhill in this environment, SVB Financial ended the fourth quarter at over $200 per share in book value.

Pershing Square founder Bill Ackman calls for a possible government bailout as “The failure of SVB Financial could destroy a key long-term engine of the economy as VC-backed companies rely on SVB for credit and to maintain their working capital.” This saga could be a source of continued volatility for the market until resolved.

My regular readers know that over the past few quarters I’ve reiterated my view that the most aggressive monetary policies since the early 1980s weren’t likely to stop until the Fed “breaks something.” We’ve already seen some spectacular explosions in the cryptocurrency markets, and we can add SVB Financial to the list of “naked swimmers” exposed to higher interest rates.

The inversion between the 2-year and 10-year Treasury yields hit 110 basis points earlier this week. The last time this happened was in 1969, 1978, 1979 and 1980. For those too young to remember, these were not good years for business or investors.

My portfolio is positioned as cautiously as it has been since the beginning of the Great Recession. About half of my holdings now are cash and short-dated Treasury bills. The remainder consists almost entirely of holdings bracketed into covered call positions to mitigate the downside risk of this simple options strategy.

I switched some more of my cash to six-month T-bills on Thursday. I doubt I’m the only investor doing this “flight to quality.” With the uncertain markets and uncertain economy, it seems like a no-brainer to earn a risk-free return of over 5% right now. There will come a time when it will be prudent to switch money back into stocks on a significant scale. However, we are far from there.

Until then, my main investing focus is ROI vs ROI.