2023 Q1 Newsletter

Overall, the New Year has seen the return of investor confidence and markets have been moving back up. As always, the path is never as smooth as we would like and in this letter, we attempt to put some of the year’s stories into perspective.

Our newsletter will focus on the following topics:

Inflation
Interest Rate Hikes
The Future and Artificial Intelligence (ChatGPT)
Silicon Valley Bank (SVB)

Inflation

As you know, over the last 2 years, inflation has been higher than what we have seen for a long time. Inflation crops up when there are imbalances in supply and demand and central banks will increase interest rates to cool demand and repair the imbalance. However we also have to consider current factors in the supply/demand imbalance:

The labour pool is shrinking as baby boomers retire
Pandemic lock-downs in China disrupted supply chains
Too much government money was given to people who did not need it, which increased demand for goods and services.

Labour shortages are likely to cause inflation to remain elevated in the service sector.

Traditionally increasing interest rates caused the economy to slow and made employers lay off staff. The recent experience where companies could not hire people has made them resistent in laying them off in the first place, especially as there are 2 unfilled jobs in the US for every unemployed person.

The employment rate in the developed world is staying at historically low levels (Source: OECD):

Canada: 5.2%
USA: 3.7%
UK: 3.7%
France: 7.4%
Germany: 5.7%
Japan: 2.3%

Overall, the actions of the central banks are having the desired results. These two charts display the monthly year over year (YOY) rates of inflation for Canada and the US. Inflation has trended down since peaking in June of last year, and inflation on goods continues to ease with US Producer Price Increases falling to 4.6% in February.

Whenever governments act, there is the concern of unintended consequences. There is a lag between central banks raising rates and inflation declining. Markets worry that with that delay in information, central bankers will raise interest rates too high, causing a recession. Rapid increases to interest rates have pushed bond prices down significantly. The rapid drop in those values likely pushed the CEO of Silicon Valley Bank (SVB) to publicly panic, causing corporations to withdraw funds, making the problem worse.

Interest Rate Hikes

The Bank of Canada made 8 consecutive rate increases from March 2022, but recently elected to pause rate increases leaving them at 4.5%. They cited data that suggests a sufficient slow down in the economy. The US Fed has increased rates 9 consecutive times to 5.0%, after the recent 0.25% hike. The US has an extremely strong labour market which is keeping the inflation data higher than they had hoped.

Markets expect the same increase in the US for the month of May.

US public confidence continues to show they are certain the Federal Reserve is taking the correct actions, an important indicator for markets. Moving forward the language of the central bank has changed from continued ongoing hikes to there may be some more hikes, depending on new data that continues to arrive monthly. Since the banking issue surrounding SVB, it has been suggested that future lending criteria may be tighter (harder for consumers to borrow money) which has the same affect on the economy as increased interest rates.

The Future and Artificial Intelligence (ChatGPT)

Increasing interest rates has the effect of slowing the economy. If the economy slows too much, companies lay off workers. Interest rate hikes can affect demand, but they cannot fix supply problems, nor can they provide additional workers where needed.

A lack of workers is a problem the rich world is facing and the issue is getting worse as societies age. We are going to need more robots and systems that automate repetitive tasks to fill in for people leaving the jobs market.

The real problem is that automating tasks we individually see as simple, is incredibly difficult.

Most robots today are simple, with stationary arms that require the implementation of very specialized production processes to allow the robot to be useful. A typical robot today has 6 degrees of motion and usually works in an area free from people. A human body, with all its digits and joints, has 244 planes of motion. A simple task like restocking cans in a grocery store is beyond the scope of most robots today. Tasks in the service industry are even harder to automate.

But what if systems could be created to “teach” these skills?

ChatGPT, has become the most talked about technological innovation. GPT stands for Generative Pre-Trained Transformer. ChatGPT, developed at the OpenAI research laboratory, is now able to converse with humans. It was trained on a very large set of language data allowing it to scan the internet at very high speeds and then write a clear and concise summary of information in response to a query.

ChatGPT (and other versions from Google and so forth ) is creating a huge amount of hype and conversation, but we would argue that at this point it is a pale reflection of the true potential of Artificial Intelligence. Eventually we should see true digital assistants helping in automating reordering supplies for companies, following up on outstanding invoices and so forth.

The Roomba is a robotic vacuum cleaner, which uses sensors to navigate the floor. But it does not recognize a spill as something that needs to be cleaned up, its job is to cover as much of the floor as it can. It just happens to also vacuum as it does so. The potential of artificial intelligence and machine learning would allow it to recognize what needs to be picked up. At some point, it may be able to dust surfaces and clean the bathroom too!

That is the true potential of artificial intelligence - releasing people to do more. Some have discussed fears of machines replacing people, but the reality is much different. New technologies bring new jobs. IBM once famously predicted the need for only a handful of computers world wide!

Silicon Valley Bank (SVB)

As I’m sure many of you have heard, Silicon Valley Bank (SVB) collapsed in the United States. It was the 16th largest bank holding less than 1% of the total assets owned by the broader US banking system. It had a select clientele of mainly start up technology companies.

Canada and the US banking systems have many similarities. Primarily, banks earn their revenue through lending. For example, when a customer purchases a GIC, they deposit money at the bank for a specified duration and collect interest. The bank then turns around and lends this money (in the form or a mortgage, loan, or line of credit) at a higher rate to another customer. Therefore after the GIC customer has been paid, the bank is left with the interest rate spread. Although the percentage difference isn’t a lot, when dealing with hundreds of billions of dollars, it starts to add up.

SVB used the pools of money its clients gave them to buy long term government bonds. While other banks started to diversify their investments when rates started to rise. SVB kept its bonds it had purchased, and they became less valuable as interest rates rose (newer bonds had a higher coupon). In addition, due to the unique clientele of the bank, venture capital (private investing) started to stall as interest rates began to rise. Venture capital is very common with start up technology companies. These customers started to deplete their savings to come up with cash to pay for expenses required to run their businesses. Overtime, SVB realized their investments had fallen below values held within client bank accounts. When news of this become public, customers started to panic and tried to withdraw all their money, exacerbating the issue.

Regulations on how the bank can invest (re-lend) customers money varies between the countries. As the regulators need to ensure the bank doesn’t try to chase high returns, and potentially risk their ability to pay customer back.

In the US, the Federal Deposit Insurance Corporation (FDIC) will insurance up to $250,000 of a deposit per customer at a bank. In Canada the current limit is $100,000.

Since SVB had many start-up tech companies, their deposits tended to exceed the $250,000 insurable threshold that would cover customers should the bank fail. As an example, JP Morgan, the largest bank in the US has a ratio of 2 uninsured clients to every 1 insured client. SVB the ratio was 22 uninsured clients to every 1 insured client.

After the news broke, other troubling aspects have emerged. Senior executives sold a large number of shares a few months before the collapse, and the Chief Risk Compliance Officer was fired early in 2022 and not replaced until 2023. One responsibility of this person is ensuring the investment pool at the bank would properly protect customers deposits should money need to be withdrawn.

A thorough investigation is being conducted by the Securities Exchange Commission of the United States (SEC) and the Department of Justice (DOJ) to see if any malice/fraudulent activity occurred.

Currently, based off the writing of this newsletter, we feel that this is not a systemic issue within the banking system. Due in part to the lack of customer diversity at the SVB, most of the problems would not get to that level at competing banks. Furthermore, governments have started to step in and provide liquidity to uninsured customers, ensuring their deposits are properly protected.

We have been monitoring this situation closely and will continue to review data and facts as they become public.

Hopefully everyone is having a good start to the year. Please reach out if you have any questions.

Jack Fournier B.Sc, FMA, CIM®
Portfolio Manager | iA Private Wealth
Insurance Advisor | iA Private Wealth Insurance Agency
700-609 Granville St. Vancouver, BC
p: 604 895 3348
jack@beaconwealthpartners.ca

Travis Kidson, B.Sc, CFP®, CIM®
Portfolio Manager | iA Private Wealth
Insurance Advisor | iA Private Wealth Insurance Agency
700-609 Granville St. Vancouver, BC
p: 604 895 3486
travis@beaconwealthpartners.ca

This information has been prepared by Travis Kidson and Jack Fournier who are Portfolio Managers for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Managers can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

Insurance products are provided through iA Private Wealth Insurance Agency which is a trade name of PPI Management Inc. Only products and services offered through iA Private Wealth Inc. are covered by the Canadian Investors Protection Fund.

Beacon Wealth Partners is a personal trade name of Jack Fournier and Travis Kidson.