March 2023 was a tumultuous month in the world of finance. On 8 March, Silicon Valley Bank, the 16th largest bank in the USA with US$209 billion in assets at the end of 2022, reported that it would incur a US$1.8 billion loss after it sold some of its assets to meet deposit withdrawals. Just two days later, on 10 March, banking regulators seized control of the bank, marking its effective collapse. It turned out that Silicon Valley Bank, or SVB, had faced US$42 billion in deposit withdrawals, representing nearly a quarter of its deposit base at the end of 2022, in just one day on 9 March.
SVB had failed because of a classic bank run. At a simplified level, banking involves taking in deposits and distributing the capital as loans to borrowers. A bank’s assets (what it owns) are the loans it has doled out, and its liabilities (what it owes) are deposits from depositors. When depositors withdraw their deposits, a bank has to return cash to them. Often, depositors can withdraw their deposits at short notice, whereas a bank can’t easily convert its loans into ready cash quickly. So when a large group of depositors ask for their money back, it’s difficult for a bank to meet the withdrawals – that’s when a bank run happens.
When SVB was initially taken over by regulators, there was no guarantee that the bank’s depositors would be made whole. Official confirmation that the money of SVB’s depositors would be fully protected was only given a few days later. In the leadup to and in the aftermath of SVB’s fall, there was a palpable fear among stock market participants that a systemic bank run could happen within the US banking sector. The Invesco KBW Regional Banking ETF, an exchange-traded fund tracking the KBW Nasdaq Regional Banking Index, which comprises public-listed US regional banks and thrifts, fell by 21% in March 2023. The stock price of First Republic Bank, ranked 14th in America with US$212 billion in assets at the end of 2022, cratered by 89% in the same month. For context, the S&P 500 was up by 3.5%.
SVB was not the only US bank that failed in March 2023. Two other US banks, Silvergate Bank and Signature Bank, did too. There was also contagion beyond the USA. On 19 March, Credit Suisse, a Switzerland-based bank with CHF 531 billion in assets (around US$575 billion) at the end of 2022, was forced by its country’s regulators to agree to be acquired by its national peer, UBS, for just over US$3 billion; two days prior, on 17 March, Credit Suisse had a market capitalization of US$8.6 billion. Going back to the start of 2023, I don’t think it was in anyone’s predictions for the year that banks of significant size in the USA would fail (Signature Bank had US$110 billion in assets at the end of 2022) or that the 167 year-old Credit Suisse would be absorbed by another bank for a relative pittance. These are a sound reminder of a belief I have about investing: Bad scenarios inevitably happen from time to time, but I just don’t know when. To cope with this uncertainty, I choose to invest in companies that I think have both bright growth prospects in peaceful conditions and a high likelihood of making it through a crisis either relatively unscathed or in even better shape than before.
The SVB bank run is also an example of an important aspect of how I invest: Why I shun forecasts. SVB’s run was different from past bank runs. Jerome Powell, chair of the Federal Reserve, said in a 22 March speech (emphasis is mine):
“The speed of the run [on SVB], it’s very different from what we’ve seen in the past and it does kind of suggest that there’s a need for possible regulatory and supervisory changes just because supervision and regulation need to keep up with what’s happening in the world.”
There are suggestions from observers of financial markets that the run on SVB could happen at such breakneck speed – US$42 billion of deposits, which is nearly a quarter of the bank’s deposit base, withdrawn in one day – because of the existence of mobile devices and internet banking. I agree. Bank runs of old would have involved people physically waiting in line at bank branches to withdraw their money. Outflow of deposits would thus take a relatively longer time. Now it can happen in the time it takes to tap a smartphone. In 2014, author James Surowiecki reviewed Walter Friedman’s book on the folly of economic forecasting titled Fortune Tellers. In his review, Surowiecki wrote (emphasis is mine):
“The failure of forecasting is also due to the limits of learning from history. The models forecasters use are all built, to one degree or another, on the notion that historical patterns recur, and that the past can be a guide to the future. The problem is that some of the most economically consequential events are precisely those that haven’t happened before. Think of the oil crisis of the 1970s, or the fall of the Soviet Union, or, most important, China’s decision to embrace (in its way) capitalism and open itself to the West. Or think of the housing bubble. Many of the forecasting models that the banks relied on assumed that housing prices could never fall, on a national basis, as steeply as they did, because they had never fallen so steeply before. But of course they had also never risen so steeply before, which made the models effectively useless.”
There is great truth in something writer Kelly Hayes once said: “Everything feels unprecedented when you haven’t engaged with history.” SVB’s failure can easily feel epochal to some investors, since it was one of the largest banks in America when it fell. But it was actually just 15 years ago, in 2008, when the largest bank failure in the USA – a record that still holds – happened. The culprit, Washington Mutual, had US$307 billion in assets at the time. In fact, bank failures are not even a rare occurrence in the USA. From 2001 to the end of March 2023, there have been 563 such incidents. But Hayes’ wise quote misses an important fact about life: Things that have never happened before do happen. Such is the case when it came to the speed of SVB’s bank run. For context, Washington Mutual crumbled after a total of US$16.7 billion in deposits – less than 10% of its total deposit base – fled over 10 days.
I have also seen that unprecedented things do happen with alarming regularity. It was just three years ago, in April 2020, when the price of oil went negative for the first time in history. When investing, I have – and always will – keep this in mind. I also know that I am unable to predict what these unprecedented events could look like, but I am sure that they are bound to happen. To deal with these, I fall back to what I shared earlier:
“To cope with this uncertainty, I choose to invest in companies that I think have both bright growth prospects in peaceful conditions and a high likelihood of making it through a crisis either relatively unscathed or in even better shape than before.”
I think such companies carry the following traits that I have been looking for for a long time in my investing activities:
- Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market
- Strong balance sheets with minimal or reasonable levels of debt
- Management teams with integrity, capability, and an innovative mindset
- Revenue streams that are recurring in nature, either through contracts or customer-behaviour
- A proven ability to grow
- A high likelihood of generating a strong and growing stream of free cash flow in the future
These traits interplay with each other to produce companies I believe to be antifragile. I first came across the concept of antifragility – referring to something that strengthens when exposed to non-lethal stress – from Nassim Nicholas Taleb’s book, Antifragile. Antifragility is an important concept for the way I invest. As I mentioned earlier, I operate on the basis that bad things will happen from time to time – to economies, industries, and companies – but I just don’t know how and when. As such, I am keen to own shares in antifragile companies, the ones which can thrive during chaos. This is why the strength of a company’s balance sheet is an important investment criteria for us – having a strong balance sheet increases the chance that a company can survive or even thrive in rough seas. But a company’s antifragility goes beyond its financial numbers. It can also be found in how the company is run, which in turn stems from the mindset of its leader.
It’s crucial to learn from history, as Hayes’s quote suggests. But it’s also important to recognise that the future will not fully resemble the past. Forecasts tend to fail because there are limits to learning from history and this is why I shun forecasts. In a world where unprecedented things can and do happen, I am prepared for the unexpected.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Ser Jing does not own shares in any of the companies mentioned.