Quarterly Commentary 1Q’23

Some Surprises for the Quarter

We entered 2023 expecting the markets to vacillate on news around the impacts of stubborn inflation, rising interest rates and the prospects of a potential looming recession. The failure of the country’s 16th largest bank was something we did not expect. Silicon Valley Bank (SVB) was seized by federal regulators on March 10. Shortly thereafter, two other banks – the crypto-focused Signature Bank and Silvergate Bank – also went under. Three bank failures in two weeks led to sudden concerns about the overall stability of the banking system. The federal government responded quickly with a new program designed to backstop deposits, helping generally restore confidence among bank depositors and investors.

Now, several weeks past the bank failures, it does appear that specific risky exposures and management missteps were largely accountable for what went wrong at SVB and the other two banks. At this point, the damage appears to be contained. (For more context see the following page.)

Markets started the year strong before retrenching on the banking news – yet they still ended with positive, if volatile, returns for the 1st Quarter of 2023. The US-based S&P 500 and global MSCI ACWI benchmarks were each up 7.5%*. Bonds were also positive with the US Aggregate Intermediate-Term Bond Index increasing 2.3%*. Large-cap tech stocks rallied as they continued to recover from last year’s lows, while small-cap stocks were weakest, in part on concerns about tightening lending standards, to which they’re more vulnerable. European stocks generally did well on stronger-than-expected growth. Community banks and other financial services companies were hit hard in the aftermath of the SVB failure.

During the quarter, the Federal Reserve continued its inflation-fighting stance, raising the federal funds rates by 0.25% on February 2 and March 22, signaling inflationary pressures are intact despite the banking turmoil. Since last March, the Fed has now raised rates 9 times, bringing rates from near 0% to nearly 5%. Inflation has slowed somewhat, with the Consumer Price Index dropping to 5% in March. This has declined from its peak of 9.1% in June 2022, but is still well above the Fed’s 2-3% inflation target. The employment picture remains exceptionally robust, with overall US unemployment at 3.5%.

We expect there to be a lag between the Fed’s rate increases and when the economy slows. Of course, just how long that lag might be or how severe a slowdown we will experience remains to be seen. The recent banking crisis has only served to muddy

* Source for Stock Index Returns: Refinitiv Datastream; Source for Bond Index Returns: The Wall Street Journal

that picture. At its March meeting, the strongest message from the Fed was around the notably high level of uncertainty in today’s economy. Economists now cite the classic signs of a coming recession: a significantly inverted yield curve in the bond markets along with a notable decline in the Leading Economic Indicators index (see graph at right). Optimists argue that the gradual signs of slowing we’ve seen so far indicate that any recession is likely to be mild and that a proverbial soft landing is underway. Some bigger-picture analysts are forecasting that climate-related spending may be large enough to keep economic activity and inflationary pressures high for an extended period of time.

It could ultimately be that it’s the banking crisis that serves to slow down economic activity as the Fed has been trying to do. In the wake of SVB’s failure, we expect to see more rigorous regulatory oversight and tighter lending standards from banks across the board. This may improve the health of the banking sector while also being an antidote to inflation.

The Big-Picture Impact of Silicon Valley Bank

Silicon Valley Bank played a unique and pivotal role for the venture capital (“VC") sector; roughly half of all VC-backed U.S. startups banked there. We don’t yet know how severely the VC world will be impacted or what entities might step into the important role SVB played in financing the innovation economy.

While SVB was important across the start-up world, it played an especially important role in financing climate-related technologies, including 60% of the country’s community solar initiatives. Of course, the last thing the battle for a sustainable planet needs is the failure of a bank financing a sizeable portion of new sustainable technologies! But there may be a silver lining here: as the dust settles it may create the opportunity for dedicated green banks to step into the void – and to better provide the kind of patient, purpose-driven capital needed in the fight against climate change. Last summer, congress and the Biden administration approved $20+ billion in funds to support the build out of green banks across the country as a part of the Inflation Reduction Act (a name we still do not love).

Overall, a loss of confidence in the banking system – community banks in particular – could be damaging across the economy. Community banks are especially essential for channeling funds to communities of color and other historically underbanked areas. The majority of community-based financial institutions are stable and serve as pillars of their local economies. While the initial response has been a flight to the larger banks, the result here could be that the SVB failure shines a light on smaller banks, perhaps attracting support that has in the past been lacking. Impact minded investors will, for the time being, continue to play a crucial role in providing funds and support for these organizations.

You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. This material is intended for educational purposes only. Nothing in this material constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Past performance does not guarantee future performance. Future returns may be lower or higher. Investments involve risk. Investment values will fluctuate with market conditions, and security positions, when sold, may be worth less or more than their original cost.