Blain’s Morning Porridge, July 7th 2020, Stocks are Smoking…

Blain’s Morning Porridge, July 7th 2020 – Stocks are Smoking… 

“Pleased to meet you, hope you guess my name..”

For the past few weeks I’ve been cautiously optimistic. The virus is bad, but the economic damage looks far less than feared. We’ve seen economies, companies, and employment fare far less badly that predicted. I’ve even gone as far as to recently declare myself bullish on recovery prospects…..

But, after a month of upside economic surprises, I sense the mood is beginning to change. There is less talk of V shapes, and we are back to more discussion about inverted L-shapes stretching into 2021/22. Maybe its summer lethargy or the renewed outbreaks in the US? Or hangovers from the packed weekend pubs that is causing the negativity?

Or, is just the realisation that although the pandemic has caused less damage than feared – it’s still caused massive damage! France thinks it’s had a great virus because its economy will only be 8% smaller! (And, on a relative basis, they might be right..!)

Not that any re-assessment of recovery expectations seems to matter to stock markets!

Next week we get the start of Q2 earnings season. A few weeks ago I was warning the Q2 numbers were likely to be brutally bad – revealing devasting negative results for many companies – and might trigger a correction. But now we have banks telling us the numbers season will surprise to the upside – Bank of America expects an 8% beat across the earnings season. That will please the Robinhood army..

Whoo Hoo! Fan these flames higher! Whoo Hoo! Buy stocks! Buy stocks! 

Alphabet (Google) has just joined the $1 trillion market cap club alongside Apple and Microsoft. Amazon tops the list and has just broken $3000 — up a real 121% since Dec 2018. The analysts are confused – they think it’s an expensive stock, but predict Amazon going higher on the back of online activity and competitive streak.

I’m a big fan of these big tech names – but are they really, really worth that much?

Financial Asset inflation means… yes, probably… for now. Although their stock prices have risen fast, (and benefited from stock buybacks fuelled by ultra-cheap debt, supported by Fed QE Infinity programmes buying their bonds…), have these firms doubled productivity and profits in the last few months – like their stock prices would indicate?

Er… no.

On the plus side, these companies make/sell good stuff that’s genuinely valuable. Cloud services, steady service revenues, and good products make the difference. (When a Tesla fanboy tries to explain the $220 bln valuation of a car company that sells very few cars is because it’s the “Apple of the car market”… then you want to reach for the little brown bag…)

Financial Asset Inflation is here to stay– for the medium term at least. I now have few expectations the world will wake up suddenly to say how overvalued stocks are. I’m less and less convinced there is going to be a sudden crash or stock market reset. Any dip, and buyers will swiftly emerge. I think we’re in for a long-period of volatile markets with little real trading outside current ranges.

Smart analysts know the ongoing overvaluation of stocks will continue to be supported by the search for yield and returns. When there are zero returns from bonds, then investors are drawn, like moths, to the stock markets. Wonder where all that QE money has gone? Look at some stock prices …

Of course, there are massive risks in a stock market supported by QE infinity. It drives illusionary valuations – Tesla being just the most obvious. Where zombie companies are thriving because of limitless free debt, the basic functioning and discipline of markets is in trouble. It encourages the survival and even apparent success of implausible tulip-like names.

Does that mean the whole stock market should be rising? Large numbers of dull, boring, predictable and profitable companies have underperformed the elite tech stocks. These are the ones to watch.

The ones which have massively underperformed are financials. Why are bank stocks doing so badly?

While the distortions caused by QE Infinity and Zero Interest rates have bounced Tech stocks and fantabulous hope-and-a-prayer-stocks, they have  absolutely crushed the banking and finance sectors. As investors realise the downside for banks is worsening and savers discover their pension pots have been massively downgraded by financial asset inflation and diminished returns, the outlook for the whole sector is miserable.

Part of the reason is the outlook – zero rates are bad news. But it’s also due to the perception regulatory control and interference makes banks a zero-sum game. Its kind of ironic. 12 years ago, the authorities spent billions to keep the financial and banking sector alive. Today, its the most disliked sector.

You know the sector is in trouble when the only positive bank investment scenario I can come up with is Deutsche Bank – basically because it’s so big and important to Germany (which desperately needs to pretend everything is fine and dandy afrer Wirecard), then I know I’m struggling. DB is up 76% since March – largely on the basis it was so cheap and bad, it couldn’t get any worse!

The NASDAQ Bank Index is down 33% this year. The MSCI Europe Banks Index is even worse!

When a Fed governor dissents from a decision to allow banks to pay dividends because she foresee massive banking challenges ahead… When the Fed slaps massive additional capital requirements on Goldman because it thinks it knows more about the risks than the Vampyre Squid (unlikely)… (Remember: the only thing worse for a bank than too little capital, is too much!)

When the Fed is so embarrassed by its last stress test it effectively degraded them to a box-tick points exercise to test not resilience, but how good their compliance is – then we’re all in trouble. OK – so the timing in the middle of pandemic didn’t help. What we got was full information on how US banks would perform in a totally imaginary downside scenario, while they were actually in the throes of a completely different and much more severe real time event.

Meanwhile, European dividends have been stopped. I really can’t see much upside investing in European banks, including these in the UK. Zero interest rates (or soon to be negative interest rates) kill opportunities for banks to earn margin and force them to undercharge for credit risk. The continental banks variously remain riddled with Non Performing Loans (NPLs), unclear derivative exposures, or a questionable attitude to money laundering.

Most banks are now run as de facto bureaucracies – answering to regulator and compliance committees rather than business imperatives. They will manage lending to meet capital ratios set by regulators by cutting lending rather than innovating new ways to allocate capital to clients.

Few management boards are thinking about how to improve customers service, or expansion into the opportunities Coronavirus present – they are all far more concerned with hitting capital ratios, making sure they pass pointless stress tests, or avoid failing KYC tests.

Ask any high street bank for a loan, a mortgage or an overdraft, and they are unwilling – customers are getting in the way of the Coronavirus response, which essentially amounts to shutting down risk business.

15 years ago the most “successful” high street banks were seen as dull, boring, and predictable dividend stocks. The global financial crisis of 2008 put an end to that. Only HSBC emerged with any kind of honour. Most banks were rescued, and Barclay’s resorted to – well the courts haven’t proved it was legal yet – capital chicanery to keep itself solvent.

The final straw for the High Street Banks might have already been written. The State Capture of HSBC by the Chinese may be the final chapter. Its been forced to kowtow over Hong Kong, support Chinese security laws and to lobby for Huawei. Its completely compromised, and it’s still entirely possible they will be closed out of Hong Kong if the UK isn’t seen to support Xi – which might be why Boris hasn’t singled out China in his latest sanctions list.

Is there such a thing as a European Champion bank?

Not really. But, maybe one is investible.

Deutsche Bank is rightly regarded as a disaster story of mismanagement, decline and undelivered hopes and promises. However, it’s now the only German banking champion. Could Europe’s worst bank could be its best?

Five Things to Read Today

FT – Federal Reserve Official Warns US Recovery May be Levelling off

BBerg – Tesla’s Overexcited Fans Should Cool Down a Little

BBerg – America and China are Entering the Dark Forest

FT – China Stocks extend rally as traders brush off virus concerns

WSJ – Google, Facebook and Twitter Suspend Review of Hong Kong Requests for User Data

Out of time and back to day job.. .

Bill Blain
Shard Capital