The month of March 2023 is one for the record books.
Historical shockwaves began on the 8th of March when Silvergate Bank announced its voluntary liquidation. This was after a crypto-based bank run forced Silvergate to sell debt securities at a significant loss due to recent rising rates.1 Just days later, two major banks, Silicon Valley (SVB) and Signature, failed within 48 hours of each other. The two failures were the second and third largest in U.S. history, representing roughly US$210 and US$110 billion in assets respectively.2 Shortly after Credit Suisse, a systemically important bank in the global financial landscape, was officially set to be acquired by long-time competitor UBS after operating for 166 years.
With market headlines including the term “bank failure” for the first time since the global financial crisis, we believe it is time to consider the behaviour of systematic risk factors in our Two Sigma Factor Lens. Of note, many of our factors had historically significant months relative to their histories, including strong reactions to the news of these bank failures.
Exhibit 1: Two Sigma Factor Lens March Performance
Source: Venn by Two Sigma. The median and percentile columns measure the performance of each factor in the Two Sigma Factor Lens relative to the entire history of the factor in USD, using monthly data for the period March 1995 - March 2023
Evaluating the top and bottom risk factors during US bank Failure news
The month of March came with heightened volatility, so to isolate the impact that bank failures had on our Factors, we analysed performance both during and after the news broke. The period labelled “bank failure news” begins on the 9th of March, the first trading day after Silvergate announced their liquidation, and ends on the 13th of March, the first trading day after the signature bank was closed by the New York State Department of Financial Services. Let’s review standout themes from our four-factor categories during this period.
Exhibit 2: Performance of the Two Sigma Factor Lens during the Bank Failure News and the Aftermath
Source: Venn by Two Sigma.
Macro factors
Our Equity Factor fell a meaningful -3.43% in the three trading days we labelled as bank failure news. Our interest rates factor (long bonds) proved to be defensive, up 2.15%.
Despite the fact that bond equity correlations have been persistently higher during this global interest rate hiking cycle, elevated correlations do seem to be dropping. For example, in 2022 our interest rates factor and equity factor exhibited a correlation of 0.38, while YTD it is -0.11.
Notably, our equity factor rallied considerably in the aftermath of the bank failure news as the FDIC announced that depositors of the banks would be protected.3 Another market tailwind during the aftermath came in the form of the Swiss central bank and UBS working together to salvage Credit Suisse.4
Secondary macro
The U.S. dollar fell roughly 2% against a basket of major currencies5 during the bank failure news, as yields fell in the U.S. and rate hike expectations became softer. A weaker dollar benefits our foreign Currency Factor when looking through our USD lens.
As shown in Exhibit 3, this included a significant rally in the Japanese Yen (Bolded in Black) and CHF (Bolded in Purple) relative to the USD, two currencies considered to be safe havens alongside the USD. Notably, immediately after the bank failure news, the Swiss Franc fell while the JPY continued to show strength relative to the USD. This Swiss Franc weakness coincided with the orchestration of the Credit Suisse acquisition by UBS.
Exhibit 3: G10 Currencies Relative to USD in March
Source: Bloomberg. Period covers the month of March. All exchange rates shown with the foreign currency as the base and USD as the quote currency.
Macro style
We recently discussed our Fixed Income Carry Factor in depth, including its short positioning in both US and Canadian 10-year bonds. As banking failures unfolded, we saw both of these bonds rally considerably (yields fell), leading to large losses for this factor. The Australian 10-year bond is an example of a long position that helped Fixed Income Carry in March, but losses in the short book were greater. Markets believed that market turmoil might bring an earlier end to the hiking cycle than previously anticipated, leading to a positive response from bond prices.6
Exhibit 5: Falling 10-Year Yields for U.S. and Canadian Bonds in March
Source: Bloomberg. Period covers the month of March.
In general, bond volatility seems to be high as markets look for any sign as to what central banks might do next, especially the Fed. This is evident from the rolling one-year volatility of our interest rates factor, which currently has volatility higher than the levels recorded during the global financial crisis and as high as the early 2000’s tech crash.
Exhibit 6: Rolling 1-Year Volatility of Venn’s Interest Rates Factor
Equity style factors
Quality and Value moved in opposite directions as the bank failure news was hitting markets, returning 2.32% and -2.67% respectively. This trend continued during the aftermath period as well, with quality outperforming value by an additional 4.5%. The dichotomy between our market-neutral quality and value equity styles during a financial crisis is nothing new. For example, during the global financial crisis quality returned 2.9% compared to Value losing -6.4%.7
From a bottom-up perspective, quality is built by favouring fundamentals such as profitability and low leverage, whereas Value favours fundamentals such as high dividend yield and low price to book. Banks, which were down -8.5% during the bank failure news,8 tend to correlate with Value more than Quality due to their capital structures and operating tendencies.
From a top-down perspective, quality is often resilient in times of market stress. During these periods, investors tend to prefer profitable companies with high earnings quality and low leverage over junkier stocks. The value represents cheap companies relative to their intrinsic value over stocks that are more expensive. For Value, the dynamics of ‘risk on’ vs. ‘risk off’ and expected performance may be less clear than Quality.
Stay tuned for more Venn analysis on the recent banking turmoil
An upcoming blog will use Venn to take a deeper dive into recent market news as it relates to banks. Please feel free to subscribe if you would like to be notified when that piece is published.
REFERENCES
1 https://www.wsj.com/articles/crypto-bank-silvergate-to-shut-down-repay-deposits-4bc2a469
2 https://www.fdic.gov/bank/historical/bank/bfb2023.html
3 https://www.fdic.gov/news/speeches/2023/spmar2723.pdf
5 As measured by the DXY Index. https://www.marketwatch.com/investing/index/dxy
6 https://www.wsj.com/articles/banking-crisis-powers-historic-bond-rally-d245641f
7 Specific period from 9/15/2008–3/9/2009
8 Measured by MSCI World Bank Index Performance from 3/9/2023–3/14/2023
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