Recently, a Silicon Valley bank in the US stock market suddenly went bankrupt, causing significant pullbacks in the US stock market, European stock markets, and others.

Some friends have asked whether this will replay the situation of Lehman Brothers' bankruptcy during the financial crisis and whether it will trigger a larger crisis.

Business Model of Silicon Valley Bank

Why did Silicon Valley Bank suddenly go bankrupt?

This has to start with its business model.Silicon Valley Bank is a California-based bank that serves businesses and institutions. Its primary clients are startups in Silicon Valley and some venture capital funds.

Its business model is primarily as follows:

(1) It accepts deposits from startup companies and venture capital funds. In recent years, with low interest rates in the U.S. stock market, the interest rates on Silicon Valley Bank's deposits are relatively low, only a fraction of a percent.

(2) To enhance returns, Silicon Valley Bank invests in a basket of securities. It has purchased approximately $80 billion worth of MBS (Mortgage-Backed Securities), most of which are medium to long-term (around 10 years or more). Under normal circumstances, the yield from these securities is higher than the interest rates paid on deposits to customers.Silicon Valley Bank can reap the middleman's spread.

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Interest rate hikes + bank runs, crushing Silicon Valley Bank

This business model, during a rate-cutting cycle, or a low-interest-rate cycle, is not a problem.

However, during an interest rate hike cycle, significant risks emerge.

(1) During an interest rate hike cycle, deposit rates will increase, significantly raising the cost paid to depositors.

At the same time, as interest rates rise, the prices of various assets typically fall.The just-concluded year of 2022 saw significant declines in the U.S. stock market and U.S. Treasury bonds.

U.S. Treasury bonds experienced their largest single-year drop since 2008, marking a major bear market for bonds.

The securities portfolio of Silicon Valley Bank, which invested in these long-term Mortgage-Backed Securities (MBS), also saw a decline in prices.

(2) This was not yet enough to immediately bankrupt Silicon Valley Bank.

However, the bank's unfavorable investments and significant changes in operations, as a publicly listed company, required the disclosure of investment losses to the public.

Upon seeing the news, depositors naturally became very concerned about their deposits and wanted to withdraw their money.

But much of this money was still invested in medium to long-term securities portfolios, which are difficult to liquidate in the short term.

As a result, the bank faced its most feared risk: a run on the bank.Banks fear short-term runs, where a large number of customers withdraw their deposits.

If customers are not in a hurry to withdraw, Silicon Valley Bank might have survived until the next interest rate cut cycle.

However, the run occurred, leading to Silicon Valley Bank declaring bankruptcy in just a few days.

During the interest rate hike cycle, interest rate risk increases.

In the case of this event, Silicon Valley Bank is only equivalent to the size of a medium-sized domestic bank.

It has not yet reached the level of Lehman Brothers during the financial crisis.

The bankruptcy was mainly due to its own investment mistakes.However, the underlying cause of the issues faced by Silicon Valley Bank is indeed related to the interest rate hike cycle.

Interest rates to assets are akin to gravity to the Earth.

The higher the interest rates, the stronger the downward force.

During an interest rate hike cycle, when interest rates rise to a certain level, it increases the likelihood of risk events occurring.

Silicon Valley Bank may be a recent, well-known case, but it is not necessarily the last one.

For instance, after interest rates increase, the pressure on growth companies becomes greater, and the financing costs for small and medium-sized companies will rise.Large companies may lay off employees to reduce costs, while small and medium-sized companies might not be able to withstand the pressure, leading to bankruptcy.

The pressure on assets will also be relatively high. Last year (2022), U.S. stocks, bonds, and real estate all experienced significant declines, which are also related to the interest rate hike cycle.

In the early 1980s, the S&P 500 was suppressed to less than 10 times the price-to-earnings ratio, also due to the high interest rates at the time.

The bankruptcy of Silicon Valley Bank and its impact on investment

What should we do about our investments in light of this event?

Ultimately, this incident is due to the U.S. stock market's interest rate hike cycle.The U.S. stock market is raising interest rates because the inflation rate is at a relatively high level, and this is done to curb inflation. Such events do not have a substantial impact on A-share investments, and A-shares are not facing similar high-interest rate risks. It is more about affecting investors' short-term sentiments. After all, when witnessing a bank failure, some investors who are not fully informed may make associations and become fearful. Silicon Valley Bank itself is not a particularly large institution, but the time from the outbreak of its problems to the announcement of bankruptcy was very short, which was unexpected by the market. This serves as a reminder to overseas investors that the interest rate hike cycle can bring some additional risks, and it raises the question of whether there are other risks in the market that have not yet been discovered. After all, last year, U.S. stocks, bonds, and real estate all experienced significant declines, and there might be some hidden dangers somewhere. Amid investor concerns, recent declines have been observed in European and American markets.For example, since the end of January 2023, the A-share market has retraced by 4.1%, while the S&P 500 has declined by 8% during the same period.

The recent decline in the European and American markets is more significant than that of the A-shares.

The U.S. stock market is currently at a normal low valuation, not yet undervalued.

The last time the U.S. stock market was undervalued was at the beginning of 2020, when we also invested in the S&P Technology and the NASDAQ 100.

Later, in 2021, we took profits when it was overvalued, and the returns were quite substantial.

If similar events lead to a short-term decline, causing the S&P 500 and NASDAQ 100 to return to undervalued levels, we would also consider taking action.Summary

(1) The apparent cause of Silicon Valley Bank's bankruptcy is the bank's own investment missteps. It invested in some medium to long-term assets with poor liquidity, which led to asset depreciation and short-term runs, resulting in bankruptcy.

(2) However, the underlying reason is the overseas interest rate hike cycle, which brings about higher interest rates and a decline in various asset prices. Therefore, the Silicon Valley Bank incident itself has a limited impact, but the market is concerned that there may be hidden risks elsewhere.

(3) Impact on investments▼A-Shares

There is no substantial impact on A-shares, mainly it is an impact on short-term sentiment.

Inflation and interest rate levels in A-shares are within the normal range.

▼U.S. Stocks

The current valuation of U.S. stocks is slightly low. If they become undervalued due to a subsequent decline, we will also consider taking action.