Fidelity: Credit Suisse rescue underlines the need for caution

Eugene Philalithis, Head of Multi Asset Investment Management, Europe

Banking sector problems have crossed the Atlantic with UBS agreeing to buy struggling Credit Suisse. While recent events are set to drive further market volatility, we outline why the collapse of Silicon Valley Bank and the rescue of Credit Suisse are unlikely to mark the start of a systemic event. However, from an asset allocation perspective, a cautious approach is warranted as the sector remains under intense scrutiny.

Key points

• Credit Suisse has been bought by fellow Swiss bank UBS in a deal that nearly wipes out equity holders and holders of AT1 bonds.
• While recent banking sector events in the US and Europe do not appear to be a harbinger of a systemic crisis, a cautious approach is warranted, with market participants nervous and banks under intense scrutiny.
• Even without any further short-term issues, recent events are likely to have longer-term consequences. This will pass through into the wider economy and impact economic growth.

UBS has agreed to take over struggling Credit Suisse. The deal comes after Credit Suisse took an emergency credit line from the Swiss National Bank on 15 March in an attempt to quell the growing market panic. The deal has nearly wiped out both equity and AT1 bond holders. Regulators will likely state that this is a one-off event, but we believe it has the potential to stop the broader AT1 market in its tracks.

Based on current information, it does not appear that the collapse of Credit Suisse and Silicon Valley Bank on 10 March will mark the start of a systemic event. Even so, we still believe that a cautious approach is warranted, especially as the situation is still unfolding. In the US, regional banks are still under pressure. Banks everywhere will be under intense scrutiny and market participants will be nervous, meaning markets are likely to be volatile for some time, even assuming no further negative news shocks.

From an asset allocation perspective, we currently have a strong underweight to credit and a strong overweight to cash. That said, we are mindful that markets often overshoot on dramatic news, and we will be keeping an eye on emerging opportunities to deploy capital at prices that do not reflect fundamental values.

While it is difficult to position for such events premeditatively, we have been highlighting the risks of such a fast pace of financial conditions tightening for some time. The fact that the Federal Reserve has been particularly aggressive is one of the reasons that we have been underweight US equities since January, and cautious on the outlook for risk assets overall. This also reinforces our relatively more constructive outlook for emerging markets versus developed market equities.

Even without any further short-term issues, recent events are likely to have longer-term consequences. Bank funding costs are likely to rise as investors demand a higher return as they digest the higher perceived risks in the banking sector. This will pass through into the wider economy with long-term implications for economic growth.

In the short-term, we will be monitoring incoming information closely for further signs of stress in the financial sector. The Federal Reserve meeting on 22 March will be an important event to set the tone for markets for the coming weeks and we will be watching incoming data for further signs of the impact of tightening seeping into the real economy.

Across our multi asset strategies, we believe it is important to strike a balance between responding to changing market conditions while avoiding knee-jerk reactions to evolving events. We continue with this approach, where our portfolios are structurally well diversified and designed to navigate changing markets.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.