Mid-week market update: Just when you thought the Treasury Department, FDIC, and the Fed had the SVB debacle fixed, the market plunged today on the news that the largest shareholder of Credit Suisse had declined to inject further equity into the troubled bank. This is what a bank panic looks like. Financial stocks in the US and Europe are cratering, though they remain stable in China.
Is this another GFC, or a buying opportunity?
What a financial panic looks like
Central bankers and banking regulators have a well-known playbook for dealing with banking crises. If a troubled bank has a solvency problem (its asset book was good but depositors wanted their money), the central bank could provide liquidity. If the bank is insolvent, the banking regulator would take over, oust management, and try to merge the bank with a larger and well-capitalized buyer. The shareholders of the problem bank would take the first hit, followed by the bondholders.
During the GFC, when Bear Stearns failed, followed by Lehman Brothers, the Fed’s hands were tied because broker-dealers were beyond the Fed’s regulatory reach. The same problem was evident during the Russia Crisis that sank Long Term Capital Management (LTCM). LTCM was a hedge fund that was beyond the Fed’s reach. Fast forward to 2023, the problem first appeared at Silicon Valley Bank, and now the crisis of confidence has migrated to Credit Suisse.
Credit Suisse senior CDS recently traded at 1000 bps,which is an almost unheard of level, as explained by this Bloomberg article
In the credit market, spreads of more than 1,000 basis points in one-year senior bank CDS are extremely rare. Major Greek banks traded at similar levels during the country’s debt crisis and economic slump. The level recorded on Tuesday is about 18 times the contract for rival Swiss bank UBS Group AG, and about nine times the equivalent for Deutsche Bank AG.
The CDS curve is also deeply inverted for the bank, meaning that it costs more to protect against an immediate failure, instead of a default further down the line. The lender’s CDS curve had a normal upward slope as recently as Friday. Traders typically ascribe a higher cost of protection over longer, more uncertain periods.
The panic can be seen in a lack of liquidity in equity and bond markets. Liquidity in the S&P 500 e-mini futures has plunged.
A similar situation has developed in the Treasury market as bid-ask spreads have widened.
Rays of hope
Amid the panic, here are some rays of hope. Insider buys (blue line) are exceeding sales (red line). They have been fairly good at spotting recent market bottoms.
Here is the pattern of insider trading during the Greek Crisis of 2011.
To be sure, insiders aren’t perfect. They were buying all the way down during the GFC, though their decisions turned out reasonably well based on a one-year time horizon.
From a technical perspective, the Zweig Breadth Thrust Indicator is at oversold levels that was only exceeded by the COVID Crash.
Current conditions indicate that risk/reward is tilted to the upside. at least in the short-term. Oversold markets can become oversold, but you would have to be betting on a catastrophic collapse if you are bearish. I believe that possibility is unlikely as the Central Banker Put is coming into play. The regulatory authorities have the situation under control and they are prepared to act.Longer term, however, much will depend on the path of monetary policy. The upcoming ECB and FOMC decisions will yield more clues to the future.
Disclosure: Long SPXL