Portfolio Update – March 2023

In 2022, the closest thing we had to a systematic risk was the pension crisis in the UK: it caused a lot of heartburn to investors, but it was rapidly solved. However, that was nothing compared to the “March Madness” we got this year. Let’s start with what contributed the most to general chaos: bank turmoil.

The first domino to fall, Silicon Valley Bank (SVB), didn’t fail because of bad assets, like Lehman, or some scandals, but rather because of pure incompetence and idiocy. The Fed announced its intention to hike interest rates back in late 2021, giving SVB and any other financial institution a few months to appropriately hedge their rate exposure. However, the management of SVB either decided to bet against that, or they weren’t competent enough to do it. Although that’s a big mistake in risk management already, the bank could have survived it if it opted to hold till maturity, avoiding having to realize the mark-to-market losses. However, the problem with SVB is that most of its customers were in the VC industry and knew each other: they started to think the bank had some liquidity problems, rushed to pull their money out of SVB all at the same time, the bank had to realize the losses to have the necessary liquidity, and failed just like that. This may have been the first case of a bank run organized through Slack.

However, what’s important for us is that to avoid similar problems in the future, the Fed injected liquidity through the Bank Term Funding Program (BTFP) by allowing banks to borrow from the discount window using treasuries (at par) as collateral.

Visual representation of how the BTFP works, by Concoda (twitter and substack)

Is this liquidity the same as of quantitative easing? Absolutely not, and there is a good Twitter thread, also by Concoda, that explains why it wasn’t. However, it doesn’t really matter: it’s never facts that move the market, but rather the perception of such facts. If the market believes it’s QE, then it will act as if it was, and you can clearly see it did so by looking at the Nasdaq this month.

After SVB, it was the turn of Credit Suisse. To be completely honest, it was just about time. Indeed, Credit Suisse has been involved in virtually every financial scandal of the last decade, its reputation did nothing but crumble (and so did the share price as well), and they hadn’t ever truly recovered from the Archegos blow-up in early 2021. In a matter of a week, they posted the quarterly results showing an unexpected big loss, their CDS surged as a consequence, and in the weekend the Swiss government made UBS acquire them. Equity holders were completely wiped out, as well as AT1 holders, thanks to a last-minute law change by the government.

Out of this story, there are two important points to consider. The first one is that by changing the law at will, the reputation of Switzerland as a financial country got heavily damaged, and we’re yet to see the consequences of such decision. The second one is that by wiping out the equity holders, bypassing the shareholders’ vote of both banks just a few months after the Saudis invested billions in Credit Suisse, you created a diplomatic conflict. Overall, making UBS acquire Credit Suisse was the right choice, but it should have been handled differently, especially if from a country like Switzerland.

The week after, the ECB hiked by 50bps despite Credit Suisse, spurring some confidence in the fact European banks didn’t have such problems. Although I don’t believe European banks are totally clean, especially when it comes to French banks, the ECB had no other choice than sticking to the plan. Indeed, if they hiked more, the fears around a credit crisis would have prevailed over any other narrative, and if instead they hiked less, investors would have interpreted it as if the situation was worse than initially thought.

The problem for Europe is that despite the hikes, inflation is still increasing and shows no real sign of stopping. Furthermore, as I said several times already, the ECB has a structural limit regarding how much can it hike before having either a terrible recession or a sovereign debt crisis, and it can’t be much further than the current levels.

It’s also interesting to see that there is a clear change in narrative regarding Ukraine underway since the start of the year: the sentiment is less supportive, and news are talking less about the conflict. If anything, it shows that European countries are slowly stepping back from continuing to fund this proxy war. Arguably, indeed, the damages of both the war and the sanctions were mostly felt by Europeans themselves, so it makes sense to stop the bleed.

Moving to the United States, inflation is still high there as well, but the Fed refrained from hiking 50bps and instead went with 25bps, saying that the bank turmoil tightened financial conditions equivalently to a few rate hikes. The market didn’t really care, because the hike decision, paired with the lack of the sentence “ongoing rate hikes” from the FOMC statement, was enough to bring back the pivot narrative. Furthermore, despite Powell explicitly saying “rate cuts are not our base scenario” at the end of the presser, the FFR futures started to price in cuts the day after already.

The market stayed buoyant for the entire month, and we continued to experience the “elevator up, stair down” price action. Fundamentals didn’t matter much, every dip was bought, and the market gapped up almost every day. We ended up closing the month with the Nasdaq up more than 20% from December’s lows, which many participants considered the proof we’re back in a bull market. The same participants, however, conveniently forgot the same thing happened in Summer 2022, just before dropping for two straight months shortly after. Furthermore, Nvidia closed the quarter up 90.11%, fueled by AI, hope, and an incredible desire to be a bagholder for years. Eventually, it will correct to the low 100s, but it’s showing so much strength that, honestly, even I am starting to think it will take much longer than we all expected.

Seeing the relentless grind up in equities, it’s easy to think this is the start of a new bull market, and that the bottom was on October 13th, 2022. However, I think this is the wrong way of reading it. No bull market starts when monetary policy is restrictive, earnings are declining, and new layoffs are hitting the headlines on a daily basis. Furthermore, if it wasn’t for the generals (Nvidia, Apple, Microsoft, etc…), the market would be much lower already, as internals aren’t showing the same level of strength.

S&P 500 heatmap of YTD gains as of April 4th, 2022 (Finviz)

Looking at the future, I think the US labor market will start to show some weakness by Summer already, which in turn will make the recession trade (long short-dated government bonds, short duration equities) more attractive. I doubt inflation will show any sign of weakness unless unemployment starts to rise rapidly. Also, if anything, the OPEC surprise production cut guarantees inflation will be stickier than expected.

Furthermore, the market is, once again, currently pricing in rate cuts by the end of the year, but I’ll gladly take the under: unless we have a crisis, and the banking turmoil wasn’t such, we won’t see any rate cut in 2023. The Fed may decide to pause, but there are still at least another 50bps in hikes before that becomes a real possibility. Regarding equities specifically, it’s almost the earnings season and I expect tech to disappoint, again. Actually, I’m surprised they haven’t warned yet.

As we saw over this first quarter, despite the fundamentals rapidly deteriorating, the market kept going up on thin air, depressing all the bears who were right on everything but market direction. At the same time, there is no real bull thesis at the moment, so my bet is that this rally is on borrowed time and, overall, that Q2 will be bloody.


Portfolio as of March 31st, 2022:

  • Longs: NEE, FPI, GOOGL, SJIM
  • Shorts: NVDA, AAPL
  • Cash roughly 70%, mostly in dollars.

If we get a correction, I believe I’ll shop around to buy a few names for the long-term investment portfolio. First, my timing in Farmland Partners was terrible, but I stand by the idea it is a good company to invest in. Hence, if I am lucky enough to see it dip to $9, I’ll add on my position. Also, after studying and following the company for a few months, I’ve decided to buy MOWI for a maximum of 8% of the portfolio, possibly around $15 on the Nasdaq OTC listing.

Finally, although I’m currently short, I’m looking to buy Nvidia as a long-term investment at around $85. This doesn’t mean, however, that I’ll short it until it reaches the target: indeed, I’ll probably start to cover my position at $120 already.