What History Says About All These Bank Failures Sometimes, bad news is good news. History says that’s the case for the recent string of high-profile bank failures. Over the past two weeks, the banking sector has imploded. Silicon Valley Bank failed first. Days later, Signature Bank collapsed. Those were the second- and the third-largest bank failures in U.S. history. Then a week later, it looked like First Republic (FRC) and Credit Suisse (CS) were going to fail, too. But bigger banks saved them from collapse with massive cash infusions. The banking sector is melting down right now. Most investors are freaking out about this meltdown, and reasonably so. After all, banks are the heart of the global economy. If they’re failing, that’s not a great sign for the economy. But oddly enough, it is a great sign for the stock market. Bank Failures Are a Buy Indicator Did you know that bank crises tend to mark the end of bear markets and the start of new bull markets? It’s true. They’re the ultimate contrarian buy indicator. The 1974 bear market ended when New York’s Franklin National Bank went under in October 1974. That very same month, a nasty bear market (in which stocks dropped nearly 50%) ended. Over the next six years, the stock market soared 125% higher. The 1984 stock market crash ended when Continental Illinois – a huge bank with over $100 billion in inflation-adjusted assets at the time – failed in May of that year. Over the next three years and change, the market powered more than 100% higher. The 1987/88 stock market crash ended in the summer of 1988, when both First Republic Bank and American Savings & Loans failed – two banks with combined inflation-adjusted assets of about $150 billion. Over the next year, stocks jumped 35%. Over the next five years, they soared about 70%. Time and time again, bank failures have marked the ending of bear markets and the start of new bull markets. Why does this happen? Because bank failures are usually the last domino to fall in an economic crisis. Banks don’t just suddenly fail. They fail after months and even years of economic hardship burdening their assets and customers. They fail when an economic crisis is already in its final innings. They don’t fail in the top of the first. Why Are Bank Failures Bullish? Importantly, when banks do fail, the government usually comes to the rescue. And when the government starts rescuing things, economic crises usually end, and recoveries usually begin. That is, when a big bank goes under, the U.S. government starts to worry about systemic risks to the financial system. So, it rushes to patch up the bank failure’s damage. It bails out the depositors, works to get the bank bought out, cuts interest rates, or creates emergency lending programs. In other words, it begins stimulating the economy. And when the government starts stimulating the economy, the economy starts to recover. Indeed, bank failures are usually very bullish for stocks because they signal impending government stimulus, which helps stem economic demise and promote an economic recovery. The only exception is the 2008 financial crisis. Bank failures in the summer of 2008 led to a big stock market crash – not a rally. But the difference is size. In the 1974, 1984, and 1988 banking crises, the total assets in the failed banks measured about 1% to 2% of U.S. GDP. In 2008, the total assets of the failed banks measured more than 7% of GDP. It was a much bigger failure and, therefore, required more time to fix. Outside of the anomalous GFC, though, bank failures have pretty much always signaled bear market endings and bull market beginnings. Therefore, the question is whether or not the current banking crisis is more like 1974, 1984, and 1988, or 2008? We believe it is far more similar to 1974, 1984, and 1988. |