More on bank earnings, the threat to democracy and playing with authoritarian ideology

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Here is today’s daily post.


My view on banks: Yesterday, I told you that bank profits have been strong. Yet, financials have been under-performing the market in 2018. Higher rates should pad the bottom line for financials, increasing earnings. And today’s reports show that this is, indeed, what’s happening. Moreover, we haven’t reached a point of credit distress where banks have been caught out under-provisioning for loan losses. That’s a way’s away. So it’s not clear to me why banks should under-perform yet at this point in the cycle.

Bank earnings match expectations but fail to light a fire under stocks

The third-quarter earnings season kicked off as expected on Friday, with three of the nation’s biggest banks delivering reports that initially impressed, but lost some of their shine as the trading session progressed.

That’s a pattern that has frustrated bank stock investors this year, as strong numbers have repeatedly failed to boost stock prices. The Financial Select Sector SDPR Fund XLF, +0.11%  has fallen 5.4% in 2018 to date, while the Invesco KBW Bank ETF KBWB, -0.88%  has fallen 5.9%. That compares with the S&P 500’s SPX, +1.42%  3% gain in the period, and the Dow Jones Industrial Average’s DJIA, +1.15%  1.9% gain.

JPMorgan Chase & Co. Chief Financial Officer Marianne Lake attempted to explain the disconnect between bank earnings and their stock price movement on the company’s earnings call, noting the “macro uncertainty noise” and overhang that has battered the markets in the last few days.

“Overthinking any one driver or conclusion might be challenging,” she told analysts, according to a FactSet transcript. “As we look at the economy, we don’t see it slowing down. It seems to be continuing to grow pretty solidly.”

JPMorgan is expecting the global economy to start to converge with the U.S. going forward, she said. Meanwhile, the U.S. is lining up for a December rate hike and more hikes in 2019, which means the continuation of a steeper yield curve—”and that should all be constructive for bank stocks,” she said.

Mark Doctoroff, global co-head of Financial Institutions Group at MUFG, agreed, and said bank stocks have been viewed harshly by investors since the financial crisis.

My view: The day of the first sell-off, I highlighted a tweet by Ralph Acampora in the title. It showed we had terrible technical internals for the market. And sure enough, there was a big two-day sell-off. Some people are blaming the algos for that because selling is now automated when we hit bad technical levels. Below is an example of the thinking.

Remember, I am in Jamie Dimon’s camp, thinking that this expansion has legs. So I see the sell-off as purely technical in nature and not a portent of recession. But notice that ‘the machines’ are now adding volatility to moves, especially on the downside. That’s going to be a problem when the economy does turn down.

Machines take the blame as U.S. stock market sells off

Investors searching for perpetrators and victims in this week’s U.S. stock market selloff pointed to a familiar source: number-crunching fund managers and machines.

The benchmark U.S. S&P 500 stock index .SPX marked its biggest one-day fall since February and added to those losses on Thursday.

The carnage followed a debt market selloff this month driven by expectations that U.S. inflation will be strong enough to warrant further rises in interest rates the Federal Reserve, but not all investors think the selling made sense.

“Warren Buffett made his fortune by buying low and selling high,” said the billionaire hedge fund manager Leon Cooperman, founder of Omega Advisors Inc. “Machines buy strength and sell weakness and aggravate the moves. There was no reason for that kind of a move yesterday.”

My view: Notice that Europe is in a much worse position than the US. JPM’s Jamie Dimon said he expects the rest of the world to move up to the US rather than for the US to move down to Europe. European shares are telling a different story. See the story from yesterday below on that.

European shares sink to 21-month lows as global selloff deepens

European shares hit their lowest in more than 21 months on Thursday following a slide on Wall Street as jitters over rising U.S. Treasury yields and signs of slowing global growth prompted broad selling of risky assets.

All sectors in Europe fell, though tech recovered some losses thanks to M&A hopes. The big U.S. technology stocks that have been the engine behind a multi-year bull market posted heavy losses overnight but clawed back some losses on Thursday.

The euro zone’s STOXX .STOXXE index extended losses during the day to close down 1.7 percent, while Britain’s FTSE 100 .FTSE fell 1.9 percent.

The pan-European STOXX 600 benchmark index was down 2 percent to its lowest level since the end of December 2016, suffering its worst day since June 25. It has lost 4.5 percent so far this week.


A lot of this is likely macro worries as JPM’s CFO pointed out. Banks are under-performing perhaps because people are looking around the corner at the next recession and unwilling to give banks the benefit of the doubt given the experience in 2007-2009. Take a look at the Economist on this front below.

Also see the problem with all the BBB-rated companies. I’ve written about this before, saying 40% of corporate bonds value came from BBB. That’s one notch over junk. And it says this economy is vulnerable when the market turns down because of the poor quality of corporate balance sheets.

Regarding the hurricane, I don’t see Michael having a big economic impact. It was a devastating storm though. ANd it may have an impact on reinsurers given their exposure to Florida’s market.

The next recession

JUST a year ago the world was enjoying a synchronised economic acceleration. In 2017 growth rose in every big advanced economy except Britain, and in most emerging ones. Global trade was surging and America booming; China’s slide into deflation had been quelled; even the euro zone was thriving. In 2018 the story is very different. This week stockmarkets tumbled across the globe as investors worried, for the second time this year, about slowing growth and the effects of tighter American monetary policy. Those fears are well-founded.

The world economy’s problem in 2018 has been uneven momentum (see article). In America President Donald Trump’s tax cuts have helped lift annualised quarterly growth above 4%. Unemployment is at its lowest since 1969. Yet the IMF thinks growth will slow this year in every other big advanced economy. And emerging markets are in trouble.

This divergence between America and the rest means divergent monetary policies, too. The Federal Reserve has raised interest rates eight times since December 2015. The European Central Bank (ECB) is still a long way from its first increase. In Japan rates are negative. China, the principal target of Mr Trump’s trade war, relaxed monetary policy this week in response to a weakening economy. When interest rates rise in America but nowhere else, the dollar strengthens. That makes it harder for emerging markets to repay their dollar debts. A rising greenback has already helped propel Argentina and Turkey into trouble; this week Pakistan asked the IMF for a bail-out (see article)…

The good news is that banking systems are more resilient than a decade ago, when the crisis struck. The chance of a downturn as severe as the one that struck then is low…

Yet this is where the bad news comes in. As our special report this week sets out, the rich world in particular is ill-prepared to deal with even a mild recession. That is partly because the policy arsenal is still depleted from fighting the last downturn. In the past half-century, the Fed has typically cut interest rates by five or so percentage points in a downturn. Today it has less than half that room before it reaches zero; the euro zone and Japan have no room at all.

A $1 Trillion Powder Keg Threatens the Corporate Bond Market

They were once models of financial strength—corporate giants like AT&T Inc., Bayer AG and British American Tobacco Plc.

Then came a decade of weak sales growth and rock-bottom interest rates, a dangerous cocktail that left many companies feeling like they had just one easy way to grow: by borrowing heaps of cash to buy competitors. The resulting acquisition binge left an unprecedented number of major corporations just a rung or two from junk credit ratings, bringing them closer to a designation that historically has made it much more expensive to fund daily business and harder to navigate economic downturns.

In fact, a lot of these companies might be rated junk already if not for leniency from credit raters. To avoid tipping over the edge now, they will have to deliver on lofty promises to cut costs and pay down borrowings quickly, before the easy money ends.

Bloomberg News delved into 50 of the biggest corporate acquisitions over the last five years, and found:

  • By one key measure, more than half of the acquiring companies pushed their leverage to levels typical of junk-rated peers. But those companies, which have almost $1 trillion of debt, have been allowed to maintain investment-grade ratings by Moody’s Investors Service and S&P Global Ratings.
  • The vast majority of the 50 deals—valued at $1.9 trillion collectively—were financed with debt.
  • This M&A-fueled leveraging of corporate balance sheets contributed to a surge in debt rated in the bottom investment-grade tier and now represents almost half of the outstanding market, Bloomberg Barclays index data show.

Search crews look for the dead and the living in Florida

(Note: This article has been changed. The original text I would highlight follows.)

Row after row of beachfront homes were so obliterated by Michael’s surging seas and howling winds that only slabs of concrete in the sand remain, a testament that this was ground zero when the epic Category 4 hurricane slammed ashore at midweek. The destruction in this and other communities dotting the white-sand beaches is being called catastrophic — and it will need billions of dollars to rebuild.

“All of my furniture was floating,” said Marquardt, 67. ”’A river just started coming down the road. It was awful, and now there’s just nothing left.”

At least six deaths were blamed on Michael, the most powerful hurricane to hit the continental U.S. in over 50 years

Political economy

The macro view I am looking to show here is one where, in many ways, we are in an environment where authoritarianism is being touted and basic democratic values are being suppressed. This is true whether you talk about fake news, voter purges, or assassinations of journalists. The authoritarian right is most ascendant here.

I don’t want to fall prey to the recency effect. But I can’t honestly say I have seen a time like this in the last half-century in the West where democracy was under threat.

Not every article in this section is definable under that leitmotif. But most are.

My view: note this post which shows a backlash against Trump in the Midwest, where so-called ‘Obama-Trump’ working class voters are moving back to the Dems.

Democrats are poised to win every Senate and governor’s race throughout the Midwest this November, and they are expected to pick up House seats in the region too.

But in their bid to win control of Midwestern state Legislatures — bodies that will have the power to gerrymander congressional, State Senate and state house districts after the 2020 census — they face a tough-to-crack Republican firewall

According to both Democratic and Republican operatives, Republican difficulties in the region stem in part from the trend among many Obama 2012-to-Trump-2016 voters to switch back to the Democrats.

Nick Gourevitch, whose Democratic firm, Global Strategy Group, is polling in the Midwest, wrote in an email: “In general, we are seeing Obama-Trump districts returning to the fold as competitive seats.”

In 2016, before the presidential election, state-backed Russian operatives exploited Facebook and Twitter to sway voters in the United States with divisive messages. Now, weeks before the midterm elections on Nov. 6, such influence campaigns are increasingly a domestic phenomenon fomented by Americans on the left and the right.

“There are now well-developed networks of Americans targeting other Americans with purposefully designed manipulations,” said Molly McKew, an information warfare researcher at the New Media Frontier, a firm that studies social media.

Politics has always involved shadings of the truth via whisper campaigns, direct-mail operations and negative ads bordering on untrue. What is different this time is how domestic sites are emulating the Russian strategy of 2016 by aggressively creating networks of Facebook pages and accounts — many of them fake — that make it appear as if the ideas they are promoting enjoy widespread popularity, researchers said. The activity is also happening on Twitter, they said.

AfD tells German pupils to denounce teachers who discuss political views

School pupils in Germany are being urged by the far-right Alternative für Deutschland party (AfD) to denounce teachers who express a political opinion.

Neutral Schools, an online portal, has been launched as a pilot project in Hamburg and the AfD has announced plans to roll out the scheme across the country.

Pupils have been invited to post anonymous complaints on the site about teachers they believe are breaking neutrality rules and criticising the AfD.

The AfD, the strongest opposition in the Bundestag where it has sat since elections last year, said the initiative aims to “strengthen a democratic and free discourse” in schools, as well as highlight the neutrality code and give pupils advice on how to act if they believe a teacher is breaching it.

The platform has sparked heated debate and the party is facing growing calls from teachers and cultural figureheads to end the project, with many accusing the AfD of adopting tactics used during the Nazi and Communist eras.

My view: Look at the SPD in Germany. This is what happens when you sell out the working class to so-called ‘neo-liberal’ ideology. Voters go further left to the Greens or to the radical right of the AfD. Social Democrats all across Western Europe are getting the same fate, one reason Jeremy Corbyn has taken the reins from New Labour in the UK.

But even the CDU is ceding ground to the AfD in Bavaria.

Katharina Schulze, the woman leading the Green surge in Germany

If the polls are right, Ms Schulze and her party will get their chance to save the world — starting with Bavaria — after Sunday’s regional election in the German state. The latest surveys predict the Greens will win 18 per cent of the vote, more than double the party’s share five years ago. If confirmed, that result would make the Greens the second-biggest party in the state, and could turn Ms Schulze and her fellow party leader, Ludwig Hartmann, into the kingmakers of Bavarian politics.

…Germany’s beleaguered Social Democrats are now at serious risk of being eclipsed by the Greens. In Bavaria, the baton appears to have passed already: polls predict the SPD will plummet to just 11 per cent on Sunday.

Alarm bells for Merkel as Bavarian allies face election slump

Chancellor Angela Merkel’s Bavarian allies are heading for their worst showing in a state election in over 60 years, a setback that risks widening divisions within Germany’s crisis-prone national government.

Polls show the Christian Social Union (CSU) will win at most 35 percent on Sunday, losing the absolute majority with which it has controlled its southeastern heartland for most of the post-war period.

ECB cannot come to Italy’s rescue without EU bailout: sources

The sources, present an economic summit in Indonesia, said Italy could still avoid a debt crisis if its government changed course but should not count on the central bank to tame investors or prop up its banks.

This is because EU rules do not allow the ECB to help a country unless this has already agreed on a rescue “program” – political jargon for a bailout in exchange for belt-tightening and painful economic reforms, an option the Italian government has firmly rejected.

Any attempt to circumvent those rules would damage the ECB’s credibility beyond repair and undermine acceptance of the monetary union in creditor countries, such as Germany, the sources said.

DUP leader says May ‘could not in good conscience’ back EU border plan

“The Prime Minister is a unionist. Many of her cabinet colleagues have assured me of their unionism. Therefore, they could not in good conscience recommend a deal which places a trade barrier on United Kingdom businesses,” Democratic Unionist Party leader Arlene Foster said in a statement.

Cabinet ministers could quit over Theresa May’s ‘Brexit betrayal’ as PM prepares ‘to pay off DUP’

Theresa May is facing the threat of Cabinet resignations after she accepted EU demands that there will be no time limit on her controversial Brexit backstop plan.

The Prime Minister told her Brexit “war Cabinet” on Thursday afternoon that a proposal to keep Britain in a customs union with the EU until a trade deal can be agreed will have no end date, leading to fears the arrangement could become permanent.

At least three eurosceptic Cabinet ministers are said to be considering quitting over the latest concession, which appears to contradict Mrs May’s promise earlier this year that the backstop would expire “at the very latest by the end of December 2021”.


Tesla just outsold Mercedes-Benz in the US for the first time

In the third quarter this year, Tesla sold 69,925 vehicles in the US. Mercedes-Benz sold 66,542.

It’s taken just eight years for Elon Musk’s upstart electric startup to topple the company that invented the car 132 years ago.

And according to Atherton Research, which compiled the report, Tesla was just 1754 shy of knocking over the other German giant, BMW.

In a note to its clients, Atherton said it expected Tesla to surpass BMW in US sales in the last quarter of 2018.

My view: The crypto bust is real.

Coinbase is shutting down its fund aimed at big investors as it pivots to a new retail product

Coinbase, the cryptocurrency exchange operator, is shutting down its index-fund as it shifts attention to a new retail offering, a person with direct knowledge of the situation told The Block. 

The poster-child of the cryptocurrency market in the U.S., Coinbase in March announced its aspirations to launch a market-value-weighted index fund to offer accredited investors and institutions exposure to the digital currencies trading on its exchange.

A person familiar with the matter said the index-fund product failed to attract the necessary number of clients, raising less dollars than the firm expected.

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