Blain’s Morning Porridge – April 8th 2019
“The eggs chase the bacon round the frying pan.. ”
In the headlines this morning: https://morningporridge.com/stuff-im-watching
News over the weekend leave me un-enlightened:
- The denouement of the Brexit crisis on Thursday? Who knows..?
- Kudlow saying its “closer” gives us no reason to think China and the US will actually sign a trade deal – it seems to be wallowing. Does it matter?
- Saudi Arabia’s Aramco attracting a $30 bln book for its new bond. How quickly we forget..
- Earnings kick off this week in the US – some say lower numbers will likely to test the stock market’s resolve and the current high valuations. Test, but unlikely to break?
- How much are consumers over-levered across global housing, and personal lending? Lots, but rates are lower for longer.. until.
- The global economy continues to look like its slowing..
- Politics remains febrile (what a great word..) around the globe: a Salvini Le Pen love in, Trump vs Democrats, Trump losing Homeland chief, and the AfD.
- Is the great Asset Reset button about to be pressed? What ARB?
- Hilarious article on Zerohedge has a senior Blackrock exec calling for ECB to start buying European equities as next stage of boosting Europe’s recovery and inflation. Really? Because it’s worked so well in Japan?
Despite all the above, markets feel unconcerned. Speaking to clients there is a distinct “been here before” mood. Is it complacency, or is it an understanding that uncomfortable news might be hyped and fake, and signals often mislead? Despite all the negativity – investment managers tend to discount the known bad news. It’s the unknowns that sink markets.. This is the last full week before the Easter break.
There are three things I’ve got on my watch list for the coming week:
1. FED Minutes on Wednesday – what do they think?
2. European banking – ECB lower for longer rates, further slowdown in Europe, (German industrial orders slipping by nearly 5%), money laundering, competition policy, and competition; just how dismal are prospects for the sector?
3. Boeing – stock price actually bounced on the back of the pilots not being to blame for Ethiopian Airlines crash. But long-term?
European Bank stocks are among the worst performing asset class – only cars are worse. Low rates, margin pressure and the deepening downturn in Europe don’t help. A host of names are trading below asset value – which tells you one of two things: either they are cheap, or the market doesn’t believe where the banks have marked their assets. (I go with the latter.)
Who is comfortable with European banks? While they might not be the trigger they will be part of the next European crisis. But now? I’m just trying to rationalise them. There are really three big negatives when it comes to European banking: i) the banks themselves, ii) the European economy and iii) the who needs banks anyway argument.
When it comes to European banks, I’m struggling to come up with a single name I could point to and say: “that’s a great bank: well managed, sound business, and meets the dream “dull and predictable” investor nirvana.” None of them pass – but I’m willing to stand corrected if readers think I’m missing something and there are names to buy.
Sentiment towards European banks is coloured by the current tumble of fines against them. They have paid out over $16 bin in money laundering and regulatory fines over the past 10years. (And that number excludes the UK banks who are well over $10 bin themselves.) Although I’d split UK banks out as separate from Europe, Standard Chartered faces a multi-hundred million fine for Iranian sanctions breaking just as their current “deferred prosecution agreement” with the US authorities expires- under which it has promised to be good.
The StanChart fines relate to activities between 2007-2014, but since then I’ve met many Iranians, (another story), who are clearly well banked and in possession of multiple credit cards, so it’s pretty clear Iran sanctions remain an open book for the SEC and guess who they are looking at. Oh? The rest of the world wants to deal with Iran? Better not say anything more… but I’d start in Paris..
Then there is the slew of Baltic money laundering charges engulfing Scandinavian banks (and maybe Deutsche). Despite the fact European banks have paid over $12 bln to Uncle Sam in Money Laundering fines, the EU has proved unable to agree on a list of money laundering jurisdictions and doesn’t even check money laundering at an EU level. Why? Some counties (including one beginning with G), enable their banks to not disclose fines (for reputational reasons). Neither can the EU agree on Banking Union or a single European Deposit Insurance Scheme; the French are in favour, everyone else who matters is against.
Meanwhile, you really can’t make up the current headlines about the political driven merger between Deutsche and Commerzbank, and the lack of progress (some would say reversal) towards European Banking Union. While banks are expected to work under the rules of the ECB, no one has agreed common rules, while ECB policy means banks struggles with margins, returns and profitability, and the legacy of broken bank lending practices essentially still unfixed since 2007. Season with economic downturn, and overlay with a layer of ECB bureaucracy and regulation to the mix and it doesn’t get any better.
The “successes” of European Banking Union has been extraordinary (US Readers: Sarcasm Alert): cross border banking isn’t happening (actively opposed by many), banks are being dragged down to the lowest common denominator, bad lending is unresolved, too-big-to-fail remains strongly entrenched as domestic vs European banking policy remains in the ascendant. When the Germans say they are against cross-border banking in order to create a German banking champion by merging Deutsche and Commerz, I can’t help but giggle.
Why bother with European banks? What is the purpose and goal of banking? It’s difficult to say anymore… banks don’t fill the same irreplaceable niche they once did in our financial ecosystem. (Global regulators can probably claim a minor success in that regard.)
Effectively banks have either become brands – with franchises in private banking (whatever that means), wealth management, less so in retail banking where actually meeting a bank clerk is less likely than meeting the tooth fairy, or they are processors of cash flows like mortgages or credit cards. Many SMEs complain their banks don’t understand their business needs, and are slow to address them. That’s particulary true when banks are in trouble, under the regulatory cosh and distrusted.
The future of banking is unclear. There are many routes: one is to optimise capital to make returns as efficient as possible, but that doesn’t neccessarilly work as it means cutting out extraneous risks, activities and services based on capital charges – not on the business case. Customers don’t respond well to organisations that drop them. Or the bank might claim to be client centric – which basically means: find them, grab them and retain them – something that’s about service, which is generally poor across Europe – especially in UK!
While Europe’s banking dinosaurs continue to cut costs and respond to regulatory fiat, we’ve got serious competition on the horizon. It’s about competing direct with the bright new service and cost focused FinTecs, reaching their market through digitisation (which financials seem genetically incapable of doing well…), and simple to use digital systems – which in many banks despair of.
(We are all aware most banks are held together by slew of antique systems held together by “Dave from IT” who has been wearing the same T-shirt for over a month, but is the only person in the bank who speaks Klingon and archaic programming languages from 1986. Sorry Dave.)
My point on European banks boils down to dinosaurs trying to survive in an environment that’s moving against them, and is under competitive threat.
Interesting to note how the Boeing stock price has performed – up then flat – since the preliminary investigation into the Ethiopian Airlines flight concluded it wasn’t pilot error and pointed to a fail on the MCAS anti-stall system – clearly Boeing’s problem.
The costs we’d expect investors to ask about Boeing’s potential future liabilities from a plane that’s proved dangerous seem to have been discounted. The effect on profitability of cutting 20% of production (the Boeing 737 Max series produces 1/3 of Boeing profits), and questions to management about the long-term policy towards developing new aircraft rather than simply updating old ones, aren’t at the forefront.
Instead, it seems the market has decided the 5000 plane 737 Max order book is too large a future income stream to be worried about. They assume the company is set to deal with any costs relating to the two crashes, that the MAX series will soon be cleared for flight operations again, and that there will be no long-term repetitional damage to the aircraft maker.
I do hope the market is right – Boeing, by default is a major part of any tracker fund. But, there are risks – including what is thrown up in the full investigation and in subsequent litigation. I heard it suggested Boeing will seek to make cases “go-away” by offering swift settlements, but we really do need to find out if they compromised on the design of the plane, investigate the claims no training was required, the complexity of the systems and how they explained these systems to crew.
I ask because I fly…. So should you!
Out of time, and on to the day job!
Bill Blain, Shard Capital