May 2023
The Fed has two mandates: keep inflation low and promote financial stability. However, to combat high inflation, the Fed has been raising interest rates very quickly. This is counter to promoting financial stability and partly why so many regional banks have failed recently .Meghan explains that banks make money by investing a large portion of their deposits. They must find a way to make a return on their investments that is higher than the amount they pay depositors. To do so in our recent zero-interest-rate environment, they would lend out money for long-term mortgages at low interest rates. They would also invest in long-term, low-interest Treasury bonds backed by the U.S. government. Now that interest rates have increased, those assets have lost value, which has threatened the financial viability of many of these regional banks. Furthermore, in our digital world, panic can spread like wildfire through social media and people can conveniently pull their funds through online banking, ultimately exacerbating the problem. This is what happened with Silicon Valley Bank and the run on its bank by depositors. The federal government is covering all depositors even if they had more than the FDIC-insured limits at SVB and Signature Bank. Jeff and Meghan agree this may potentially encourage banks to take on more risk because they know they can be bailed out by the Fed.
Meghan and Jeff say it is not wise to keep deposits in a bank that are above insured limits. If individuals or businesses have a need to keep large deposits in a bank, Meghan encourages them to consider programs that increase their FDIC limit. For example, ICS (Insured Cash Sweep) spreads a large deposit out to different banks so that each deposit is below the FDIC-insured limit. This is particularly appropriate for large business accounts. Many Morton clients have money invested at Schwab or Fidelity. These broker-dealers do not hold and invest assets the way banks do; they are much more diversified and make money on trading and other service offering fees. In the very unlikely event that Schwab or Fidelity should fail, Jeff surmises that the government would step in as they each hold over 35 million accounts.
The S&P 500 was up 7% while international stocks were up almost 9% in the first quarter. Meghan says this may be a relief rally, recovering some of the heavy losses stocks incurred in 2022. Another phenomenon that has pushed stock prices higher is that bad news is seen as good news; Meghan highlights how disappointing economic data counterintuitively supported stocks because the market assumed that the Federal Reserve would slow down their interest rate hikes to support the economy. However, this is not necessarily a healthy market rally because the stocks that have been doing well are very concentrated, particularly in tech. Apple, Microsoft and NVIDIA drove 90% of the returns in the S&P 500 while companies in healthcare, finance, utilities, and energy were down.Meghan ends the discussion on stocks with a brief overview of the international markets. She emphasizes how a diversified stock portfolio should include some exposure to international stocks because from a valuation point of view they are attractive as compared to domestic stocks.
Jeff and Meghan emphasize the fact that Morton owns gold because we think of it as a store of value that is not exposed to the same risks as the stock market or real estate. Jeff says, “The beauty of owning gold are the risks you don’t take by owning it.” Meghan says gold shouldn’t be viewed as an investment to be bought and sold but instead as a currency substitute.
The bond index is up roughly 3%. For the first time in a long time, Jeff feels excited about bonds as investors can target mid- to even high-single-digit returns without taking on undue risk.
Many depositors have fled regional banks and moved their money to larger banks. Therefore, regional banks have stopped lending as much as they did before. Private lenders are benefiting from the lack of competition and can now raise rates on their loans. Meghan discusses how private lending has been a core part of our investment allocation going back to 2010. She is excited about newer investment vehicles that will help to broaden the access of these opportunities to more investors.
The outlook for real estate equity is very specific to which sub asset class (apartments, office, retail, etc.) of real estate one is invested in. Office buildings never recovered fully after the pandemic since so many companies have switched to remote work. Thankfully, Morton’s exposure to office real estate is very limited. Meghan also warns that due to higher interest rates and bank runs, some real estate owners who are trying to refinance their loans may be in trouble. Thankfully, Morton focuses on investing with managers that favor fixed-rate debt and are thoughtful about risk management. Going forward, there could be opportunities for investors as these real estate owners who cannot get their loans refinanced will have to be bailed out and sell their properties for a lower price.
Overall, Jeff feels the recent turmoil around bank runs, inflation and high interest rates has bolstered his conviction that diversified and resilient portfolios are key to protecting Morton’s clients.
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Watch our previous quarterly updates from The Better Investor series below:
Symposium Recap & Q3 2023 Market Outlook
Disclosures:
The information presented is for educational purposes only and should not be relied on for investment recommendations. It should not be assumed that Morton will make investment recommendations in the future that are consistent with the views expressed herein. References to specific investments are for illustrative purposes only and should not be interpreted as recommendations to purchase or sell such securities. Past performance is no guarantee of future results. All investments involve risk, including the loss of principal.
