What a week it was! Though we dodged a bullet with SVB, it seems that the greatest hits from banks just keeps coming
Last year, I was thinking that we were in a stock market crisis due to inflation and Fed’s monetary tightening.
I was wrong.
Here’s what we are seeing now:
– Fed tightening in face of persistent inflation
– A stock market crisis
– A banking crisis
– Layoff Contagion
– Slow motion real estate crash
– Crypto meltdown
– A long drawn out war + China cozying up to Russia
Are we in multiple crises? Yes, everything is happening everywhere, and all at once. In real time.
But we have seen this movie before.
Every crisis contains opportunity, and this one is no different. There is also a scenario where we may avert this crisis.
Let’s get into today’s edition.
In today’s edition
- Everything Everywhere All At Once
- Resilience: Cash, efficiency, and reinvestment
- My take: What happens next
1. Everything Everywhere All At Once
Just when we thought the SVB crisis was over, we saw First Republic and Credit Suisse join the party.
Let’s get a bird’s eye view of what’s going on in business and economy.
A. Fed Policy
Let’s take a quick step back.
The Federal Reserve has only two mandates:
a) Price Stability: in English, this means maintaining inflation at a ‘goldilocks’ rate of 2% to ensure economic growth.
b) Full employment: ensure sustainable max employment.
As you know, inflation is still raging at 40 year highs. Post-pandemic, we not only had full employment, but a tight labor market.
Which means, the Fed has ammunition to raise interest rates.
Exhibit 1 is Fed’s Quantitative Tightening (QT) policy. It is the fastest and furthest QT than any time in history. The intent is to rope in inflation, but it is causing unintended consequences like the latest banking crisis.
B. Banking Crisis and Managing Contagion
As I’d mentioned in the last newsletter, banks are facing over $600B in unrealized losses. Which is fine if there are no major outflows.
But when customer outflows increase and inflows decrease, banks don’t have enough liquid money to take care of customer transactions. We are seeing many banks under stress:
- Silvergate and SVB were backstopped by the FDIC and Federal Reserve.
- First Republic Bank was saved by its rivals: a group of 11 lenders including J.P.Morgan, Bank of America, Citigroup and Wells Fargo.
- UBS is buying Credit Suisse for $3B with the Swiss government providing a backstop.
At time of this writing, Fed is coordinating with other central banks to provide liquidity and stop this contagion.
The Fed’s balance sheet is starting to grow again after recent tightening (see below).
C. Real Estate is experiencing a slow motion crash
According to Goldman Sachs, home affordability is the lowest in recorded history which means this is the hardest market to buy for the average American (see chart below).
Also, demand is crashing to the floor in key markets.
D. It’s Complicated
As if things were not exciting so far, there are some additional complications:
- Markets are under pressure: For the last TTM (Trailing Twelve Months), S&P 500 clocks in at -12.2% and the Nasdaq at -15%.
- Layoff Contagion: Tech layoffs are happening at a pace of 2,251 per day are starting to impact the rest of the economy.
- Crypto: we’ve had more dominoes falling after FTX’s $32B fiasco *cough* fraud *cough* like Genesis, BlockFi, Voyager, and many others.
- War: with China cozying up to Russia, things are becoming more fluid in the Ukraine war.
2. Resilience: Cash, Efficiency, and Reinvestment
“A rising tide floats all boats….. only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffet.
It is during times like these when real leaders step up to do the right things and not just to do things right.
Resilience and fortitude become the key tenets of navigating these waters.
A. Controllables and Uncontrollables
We can’t control external factors like inflation and Fed policy. But we what we can certainly control is our strategy and our actions.
B. Conserving cash by driving efficiency
Cash is king, queen, and the whole deck of cards. Creating efficiency is now the way to move forward. Even a company like Meta that has hiring and spending during the pandemic years now has a mantra of ‘flatter is faster’.
We are saying multiple ways of driving efficiency in our client work: massively simplifying business processes, driving automation, and redesigning organizations towards outcomes not activities.
C. Reinvestment
Cash is valuable.
But what’s even more valuable than cash? Re-investing in the right areas of the business.
Think about it.
Right now: you can get top talent for a better rate. You can negotiate with your vendors. And you can get technology capabilities at better terms.
There has not been a better time in a while to reinvest in the business for long term growth and competitive advantages.
3. My take: what happens next?
A. Paying the piper
The ‘everything’ crisis is here.
We have enjoyed the fruits of easy money for just a bit too long. In a way, this crisis is like atonement for our sins.
We will likely to go through a period of value compression, demand destruction, and uncertainty. Possibly we are either in a recession or pretty close to one.
B. There could be a knight in shining armor: lower inflation
However, there is a potential scenario that all of this bad stuff might be short lived: if inflation goes down.
If we look at the latest CPI numbers, inflation is falling. Whether we look at all items of ex-food and energy, it seems the Fed’s policy is working.
So if inflation indeed goes down, then the Fed no longer needs to have higher interest rates and a majority of these crises can be averted.
C. On the other side: abundant energy, compute, and AI
Whether we go through some immediate-term pain or it’s here for a while, there is no question that we are going to see amazing value creation on the other side of this:
- ‘Unlimited energy’ through fusion and solar in a ‘J’ curve followed by EV adoption.
- We take care of climate change and no longer have to burn through fossil fuel.
- Unlimited energy can power unlimited compute and AI.
- AI becomes the defacto co-pilot for every professional which supersizes productivity. What Microsoft demoed the other day is just a glimpse of what’s possible in the very near future.
- Technology becomes truly available and democratized to every part of society.
The future is so bright, we will have to wear sunglasses!
Wrapping Up
In summary, the current “everything” crisis presents significant challenges for leaders, but it also offers opportunities for growth and reinvention.
By emphasizing resilience, efficiency, and reinvestment, we can navigate these tumultuous times and emerge stronger than ever.
