Yesterday we wrote: “Charles Schwab, whom we noted last week has been downgraded and is losing depositors at a panic rate, only has a contagion index number of 1…”

To which reader Valerie M a répondu: “Um…

My trading account is with Charles Schwab. Originally it was OptionsXpress, but Charles Schwab bought them out and never gave me a reason to switch to another trading service… until now–maybe?

Valerie is not the only one to express this exact concern. We’ve also heard from readers who hold accounts with TDAmeritrade – also in the process of being acquired by Charles Schwab. As both those firms are where a lot of readers do their self-directed, individual trading, today seems like a good time to interrupt our regular programming and address those specific concerns.

We had planned a long, editorial exposition of Man, Economy and State by Ludwig von Mises as it pertains to “price discovery” and booms and busts and the credit cycle… Plus how all that leads to a banking crisis.

Our very own, present-day banking crisis has forced our hand for now. We’ll hit Mises tomorrow.

Reader Valerie gives some context to her question:

I know you aren’t supposed to give personal advice. But for the sake of any of your readers besides myself who might find themselves in similar circumstances… could you just talk about what in general could happen to our trading accounts if/when Charles Schwab folds?

Clearly the bank and their depositors would not rate a bail out, as with a contagion index of 1 they do not pose a systemic risk. Do securities and funds held in a trading account count as deposits under the FDIC? Or would the trading accounts remain intact and that aspect of the business be sold off to another financial institution?

Is the trading platform something completely separate from Charles-Schwab-the-bank from which depositors are fleeing like rats from a fire? Just how does all this work… and what is the risk of doing nothing?

We’re going to “unpack it,” as they would say in graduate school when debating philosophies.

First, Valerie, you are correct. There is what’s known as the “Chinese wall” between our ideas and traditional fiduciary money plays.

Foremost we are writers, authors, analysts, publishers, marketers and entrepreneurs. Please, do not take what I’m saying here as specific, personal advice to do something, anything with your money. It’s your money. And before you make any decision you should seek professional guidance.

“The lady doth protest too much?” Shakespeare wrote once, meaning “guilty as charged.”

To which I would reply “I’m not a lady,” and “No.”

We’ve been on the hot end of the regulatory stick before. It’s not fun. I’m publishing these opinions to over a hundred thousand people at the same time. What is required is the necessary grain of salt.

Phew. Done with the disclaimer. Thank you.

Now, we can move on to our inquiries. The first thing you need to know is Charles Schwab’s business is broken into two distinct businesses: One is the brokerage, of which you’ve indicated you are now a customer by virtue of the acquisition of OptionXpress.

The brokerage business is still strong. All reports indicate they are still moving forward with the acquisition of TDAmeritrade. Business as usual, on that front. You may see some changes in fee structure, but that’s where Schwab makes its money, so it is what it is.

The second part of Schwab’s business is itself a bank.

Trading accounts and banking accounts are insured by the FDIC up to the $250,000 threshold. The only systemic risk there would be if the FDIC doesn’t have the funds to back up accounts across, well, the whole system (which they clearly don’t). Austrian-trained economists are not great at math, but $17 trillion in accounts backed up by $130 billion in capital doesn’t seem like a good ratio.

Depositors in the bank part of Charles Schwab have been “reallocating capital” from their accounts to money markets and other “cash-like” instruments that are benefitting from rapidly rising interests at the hands of the Fed. That’s what has institutional investors in Schwab spooked. And why they’re selling the stock.

We paraphrase from our investment director, Zach Scheidt, here in bullet form:

• Investors are taking a “shoot first, ask questions later” approach to financial stocks
• Schwab’s brokerage business is still strong
• There isn’t the same liquidity risk because brokerages don’t commingle funds the same way banks do…
• The company’s bank may have a bit more stress– but doesn’t warrant this much selling in the stock

“Right now we are at the cusp of what is going to be the largest credit default cycle in history,” Porter Stansberry, our guest this week on The Wiggin Sessions, asserts. “And if you look at the investment grade universe, the largest tranche of investment grade that has grown even larger as a percentage of the total is the double B tranche. The lowest quality investment grade. And a whole bunch of that’s going to get downgraded over the next, I would say 36 months.”

He’s not referring to Charles Schwab specifically, but what typically happens when good companies get unfairly maligned during crises or market downturns.

“When the tide turns in the credit markets,” Porter intones, again specifically about corporate bonds, “it’s really interesting. Those investors, all those institutions get paid to not take risk. So the moment something gets downgraded, they just dump… There is no attempt to analyze it or to think about it, they just want it off the books.”

Here we return to Zach, referring specifically to Charles Schwab (SCHW):

• SCHW is more of a “special situations” opportunity…
• As panic subsides, shares should move back from their current level (near $54) to where they were trading previously (closer to $75-$80).
• The company is expected to earn $4.12 per share this year, $5.10 in 2024 and $6.20 in 2025
• That’s solid profit growth and at its current price SCHW looks like a unique discounted opportunity
• I don’t expect SCHW to stay this low for long- this would be a quick trade to sell once it gets close to the $75-80 target range

Charles Schwab is presenting itself as the kind of opportunity we will always look for in a crisis setting.

Valerie, we realize that was a long-winded answer. But it does summarize where we believe we stand.

Schwab is getting unfairly punished by institutional investors in the stock market. Yet, the core business is sound.

We recommend it as a “special situation” buy. We don’t think the brokerage accounts will be sold off to other businesses. In fact, they’re likely to be considering acquiring more brokerage accounts as their business strategy has indicated.

Of course, in deference to our paid-up members of The Essential Investor Platinum service, we’ll refrain from publishing the target “buy up to” and “sell at price”. If you’re interested in learning more, please become a member of our paid service.

One mantra we follow: “Our analysis is free” but if you want advice, please subscribe.

Follow your own bliss,

Addison Wiggin
The Wiggin Sessions

P.S. Charles Schwab getting unfairly beaten down presents an interesting case in our ongoing examination of “The Anatomy of a Bust.”

We’ll be covering all this and more during our Wealth365 appearance on April 17, 2023. Join me for free, right here.