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- Wall Street experts see a new era ahead for markets, marked by a more difficult investing environment.
- Higher rates have burst the bubble in asset prices, while bank struggles threaten a wider downturn.
- The new regime will be a far cry from the nearly ideal conditions investors navigated through the last decade.
The idyllic market environment that dominated the past decade is over, and investors are at the dawn of a more difficult era, Wall Street experts say.
Warnings from commentators are coming after the stunning collapse of Silicon Valley Bank, which shook confidence in the US banking system after it was taken over by the FDIC earlier this month. More banks in both the US and Europe have since shown signs of weakness, sparking fears that a new financial crisis could soon unfold.
Observers have blamed the banking panic on the Federal Reserve's aggressive rate hikes over the past year, which have dramatically raised the cost of borrowing, drained the market of liquidity, and put an end to the era of easy money.
While ultra-low interest rates and ample liquidity previously caused stocks to swoon to new highs, SVB's collapse is a sign that bubble has burst, commentators say.
Now, they're warning of a handful of obstacles in the new era that investors are going to be forced to navigate.
A coming recession
A downturn is likely in the cards, as turmoil from SVB's downfall has significantly raised the odds of a recession, experts say. That's because banking woes naturally slow the economy. Combine that with tightening from the Fed, and the recipe for a recession is there.
Central bankers have already raised interest rates over 1,700% over the last year to quell high prices. Despite the volatility in bank stocks, Fed officials raised interest rates another 25 basis-points this week, bringing the effective Fed funds rate to 4.75-5%.
That's the highest interest rates have been since 2007, and the impact of SVB's collapse is likely equivalent to another 50-75 basis points in rate hikes, Moody's chief economist Mark Zandi estimated, meaning real interest rates are even more restrictive.
"That's a pretty significant increase in interest rates, and I do think that puts the economy in jeopardy," Zandi warned in a recent interview with CNBC.
Goldman Sachs also raised its odds of recession in 2023 from 25% to 35%, and bond markets have flashed signs of an incoming downturn as the inverted Treasury yield curve begins to de-invert. Though the inversion itself is a classic recession warning, the undoing of the inversion is a signal that a recession could come in the next four months, "Bond King" Jeffrey Gundlach said, calling it a "red alert recession signal" in a recent tweet.
More bank failures
More banking troubles could also be looming, as the recent crisis is actually a worldwide phenomenon that started long before the SVB began to stumble, according to Harvard economist Kenneth Rogoff.
Some experts have argued that SVB's collapse was due to the bank's uniquely high exposure to bonds, which have been weighed down heavily by rising interest rates. But the problem is likely more widespread, Rogoff warned, which will be exposed as rates tread higher.
"What happened is Silicon Valley Bank is maybe a little extreme in its naivete, but almost any kind of investment strategy that had illiquid assets — longer term assets — is going to lose money like this," he said in a recent interview with Yahoo Finance. "I didn't know it would [start] in the US banking sector."
Though Fed Chair Powell and Treasury Secretary Janet Yellen have assured markets the US banking system is sound, neither is in a position to offer blanket insurance on all banking deposits, according to market veteran Ed Yardeni, who said the banking sector may be weaker than officials have suggested.
Luke Ellis, the CEO of the world's largest public hedge fund, Man Group, said he anticipated a "significant' number of banks failing within the next two years, adding that there were would similar deals like UBS's emergency takeover of Credit Suisse.
Stagnant stock returns
Finally, stocks are unlikely to replicate the stunning returns over the last decade.
Nouriel Roubini, Wall Street's "Dr. Doom" economist who has repeatedly warned of another financial crisis, predicted stocks and bonds would see dismal returns for years as inflation and interest rates remain high. Higher rates weigh heavily on both assets, he said, urging investors to flock to inflation hedges like gold and inflation indexed bonds.
Billionaire investor Leon Cooperman warned that the US was already going through a "textbook" financial crisis -- meaning the S&P 500 won't notch a new high for a long time.
"I think the 4,800 on the S&P will be a high that will stand for quite some time," he said in an interview with Bloomberg, referring to high reached in January 2022. "I expect returns in the S&P to be very pedestrian."
Stocks plummeted 20% in 2022 as the Fed began to raise interest rates, and, despite a blistering rally to start the year, the S&P 500 has already erased most of its gains in 2023.
Bearish market commentators are warning of an even steeper drop in equities ahead, with Morgan Stanley forecasting a 26% drop in the next few months, and legendary investor Jeremy Grantham sounding the alarm for a 50% crash in stocks.