SVB Collapse Is Positive for Industrial Technology

 | Mar 20, 2023 12:04

The collapse of the Silicon Valley Bank rattled the markets, but the consequences are yet to be felt. In this report, we dive deeper into why we believe this is a systematic problem and why it creates a positive setup for industrial technology.

Our base case framework for the next five years is very slow economic growth, high inflation , and interest rates (10Y) at ~3.5%. We believe that productivity improvement will be the only way to address inflation on a structural basis. Industrial technology can outperform in this type of environment.

Contents:

  • SVB collapse, consequences, and implications for technology
  • Role of productivity improvement in addressing inflation
  • What we learned from industrial tech earnings - identifying focus areas within our macro framework
h2 Why SVB is a systematic problem /h2

We believe that SVB was not a one-off but a systematic problem that is just starting to trickle across the banking system globally. While the SVB collapse was caused by a unique set of circumstances (i.e., a concentrated depositor base reliant on the VC ecosystem), we believe this was the catalyst, not the underlying problem. Rapid increases in the risk-free rate have created large unrealized losses on the balance sheets of many institutions (including, but not limited to, banks).

While the public equity market was very quick to price in the rapid interest rate increases, with many high-growth stocks down 70% from their peaks by 2Q22, only months after the Fed began tightening, other asset classes were not marked down as quickly even though they are facing the same dynamic. The challenges are not only limited to banks/MBS but include:

  • Risky FCF negative private investments marked at a premium to their publicly traded comps
  • Potential bankruptcies from companies that have maturities coming due in the next two years, needing to replace free money with debt at prevailing market rates (if that is even an option)
  • Auto loans issued at ~1% interest rate on car values above MSRP
  • Corporate loans to risky (FCF negative) companies with lower interest rates than the risk-free rate
  • Convertible debt that yields ~0% interest with way out-of-the-money options
  • Governments outside of the US that are reliant on borrowing (e.g., Japan)

The consequences have started to emerge over the past week: regional banks are under pressure, which will likely lead to more consolidation in the US. European banks are under severe pressure already, resulting in bank rescues (UBS (SIX:UBSG) stepping in to take over Credit Suisse (SIX:CSGN) almost entirely wiping out equity holders with heavy government guarantees). Likely more to come.

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In short, every time the 10Y reaches 4%, something breaks. In October/November, we had the UK Pension crisis and the FTX collapse. While the market wrote off those two events as isolated, the banking crisis is very different. We believe that this crisis creates a ceiling for the 10Y, and even if the Fed continues to raise interest rates, it will be hard to push those to the real economy.

Ceiling on interest rate is a significant positive for technology stocks, as they have already taken a significant hit and are pricing in a risk-free rate of >4% (10Y). Moreover, we believe an environment of persistently higher inflation will be positive for industrial/B2B companies as productivity improvement will be key in structurally bringing down inflation.