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Throughout this week, I’ve been thinking about the collapse of the technology’s world premier banking institution – Silicon Valley Bank. And oddly enough, I‘ve come to the conclusion that it could be a very bullish signal for stocks.

In fact, the bank’s collapse may have marked the crescendo of the bear market. 

It really all boils down to one thing: SVB’s collapse was a “Goldilocks” crisis that will likely spark a Fed pivot without collapsing the economy. 

This is a serious-enough situation to illustrate that cracks are forming in the financial markets because of the Fed’s rate hikes. If the Fed keeps playing aggressive offense with the rate hikes, what happened at SVB can and will happen at lots of other banks. It may end up being an enormous financial contagion.  

But alone, SVB’s collapse is also not serious enough to cause a still-pretty-healthy U.S. economy to fall into a recession. 

SVB had total assets of $211 billion, almost all of which were centered around the startup tech world. Compare that to Bank of America’s (BAC) $3 trillion in assets across all sectors, and you’ll start to see why the SVB collapse was a wake-up call – not an economy-crusher. 

What happens next?

We think the Fed will heed this warning. It should slow its roll with rate hikes and likely pause this rate-hike campaign in either March or May. If that happens, the U.S. financial system will be resecured. The economy will re-stabilize. And stocks will likely burst into a new bull market. 

Indeed, this is exactly what happened in 1998. 

Silicon Valley Bank Collapse: A Warning, Not a Death Sentence

A lot of folks are likening the Silicon Valley Bank collapse to Lehman’s failure in 2008. But in truth, it is much more like Long-Term Capital Management’s failure in 1998. 

Lehman Brothers had over $600 billion in assets when it failed. Its collapse wasn’t a wake-up call. It was an economy-crusher. 

But like SVB, LTCM only had between $100 billion to $200 billion in assets when it collapsed in 1998. That was a wake-up call. 

And the Fed listened. 

LTCM failed on September 22, 1998. A week later, the Fed cut interest rates. What was a slowing economy in 1998 turned into a booming economy in 1999. And what was a falling stock market in 1998 became an explosive stock market in 1999. Check out the chart below. 

A graph showing the change in the Conference Board's Ten Economic Indicators YoY, Fed funds target rate and the S&P 500 during the Long-Term Capital Management collapse

History appears to be repeating here – at least, the bond market thinks so. 

The 2-year Treasury yield famously tracks the Fed Funds rate. It also famously doesn’t have much volatility. 

But the 2-year has collapsed by a dramatic 75 basis points over the past five days. That represents one of the most violent and drastic drops in the 2-year Treasury yield ever.

The historical precedent here is a Fed pivot. 

Drastic Moves in the 2-Year Indicate a Soon-To-Be Dovish Fed

That is, since 1985, dramatic downward moves in the 2-year yield have always spurred dovish Fed action. 

Specifically, whenever the 2-year yield drops more than 50 basis points over a five-day stretch, the Fed has historically cut rates within weeks. 

Remember: The bond market is the biggest, most powerful market in the world. Today, it is giving us a huge signal that a Fed pivot is here. 

A graph showing the change in the 2-year Treasury yield compared to the Fed funds target rate

Why is a Fed pivot so bullish? 

Well, a Fed pivot from rate-hike cycles – otherwise known as a “Fed pause” – systematically sparks stock market rallies. 

The Final Word on Silicon Valley Bank

Every single time the Fed has paused its rate-hike cycle in the past 40 years, stocks rallied over the next few months with returns often running north of 20%. 

A graph showing the change in the S&P 500 compared to the Fed funds rate

In other words… 

Fed pauses systematically spark stock market rallies. And these pauses always follow 2-year yield plunges. The 2-year is plummeting right now because of financial contagion fears, which are high because of the Silicon Valley Bank collapse. 

Following that logic, SVB’s failure should lead to a big stock market rally, by creating sufficient financial contagion fears that push the Fed into ending its rate-hike campaign. 

Of course, if SVB were the second coming of Lehman Brothers, things would be different.

But we think that’s unlikely. Instead, it’s the second-coming of LTCM. After LTCM failed and the Fed played the part of “white knight” to save the day, the stock market soared into one of its most explosive eras ever. 

We think history is about to repeat. 

If so, it is time to buy the dip. 

Find out what stocks we’re buying right now.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.

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