So the big four banks have now all reported — kicking off the third quarter earnings season. And all have beaten earnings and revenue expectations.
As we discussed the past few days, business is booming for the banks, and not only are the fundamental tailwinds very, very strong — but the banks will continue to juice earnings by “releasing” the war chest of loan loss reserves.
With the above in mind, if we took a straight average of the trailing twelve month P/E of the biggest four banks in the country, we get about 11 times earnings. That’s well less than half the P/E of the broader market. As I said yesterday, the bank stocks are cheap (dirt cheap).
Adding to the tailwinds for the banks, will be the rising interest rate environment.
On that note, the inflation data we’ve see continues to point to a scenario where the Fed’s hand will be forced — to quickly pivot from emergency mode into inflation fighting mode. That pivot will likely be quicker and more aggressive than the majority of Fed officials have publicly projected.
Just in case anyone thinks the U.S. inflation data might start petering out, let’s take a look at what’s happening in China, where the products are made that we will be buying in the many months ahead…
Overnight, China reported the hottest prices for producers in 26 years …
And when the producers get those final products on a ship, you can see in the next chart, what has happened to freight container prices coming from China …
So, if you are lucky enough to get your product on a ship, you’re paying nearly fourtimes as much to get it here, compared to a year ago.
We looked at these same charts in my June Pro Perspectives notes, when the Fed was successfully convincing Wall Street that inflation would be temporary. The price signals from China were telling a very different story. And here we are four months later, and that story continues to be a “hot inflation” story. And not a temporary one.
As expected JP Morgan crushed earnings expectations this morning. The biggest bank in the country has now beat on earnings and revenues for six consecutive quarters, since the depths of the pandemic economy.
We talked about the war chest of loan loss reserves the banks are sitting on, all at their disposal to turn into net income at their discretion. JP Morgan moved another $2.1 billion to the bottom line for Q3. And they still have another $6 billion remaining, to move to the bottom line, before these “loan loss allowances” return to pre-pandemic levels (of Q4 2019).
With that pre-pandemic comparison in mind, JP Morgan has now generated $50 billion in net income over the past four quarters. That’s $14 billion more (about 38% higher) than the record level profits of 2019.
So, business continues to boom for the banks. At JPM, deposits are up 20% compared to the record levels of last year. Investment assets are up 29%. Investment banking fees are up 60%. And wealth management assets are up 17%.
This is all thanks, in large part, to this chart (a deluge of new money), and a Fed that has been the backstop for risk taking for the past nineteen months.
Bottom line: The banks are profit printing machines, and will be for the foreseeable future. And bank stocks are cheap.
As earnings kick into gear over the next few days, the expectations are for another big quarter of earnings growth, just shy of 30% year-over-year growth.
That's a big number, but no where near the 90%+ (yoy) earnings growth of Q2. But as time passes, the numbers are (and will be) measured against a higher functioning economy of a year prior.
The key spot to watch in this earnings season will be margins. The record level margins of Q2 of S&P 500 companies (which was 13%), are expected to come in slightly lower (at 12%). That's the vulnerable spot, for companies that are NOT having success in passing along higher costs to customers.
So there will be winners and losers in this earnings season. And this underpins the regime change underway, from a passive investing market, to an active investing market – where there are winners and losers, sector to sector and within sectors. It's (finally) a stock picker's market.
With that, we enter Q3 earnings as the broad market has continued to stair-step lower over the past month. Let's revisit the chart …
The broad market still looks like a deeper decline is ahead. We've been watching this 200 day moving average, which now comes in about 4% lower (about 8% peak to trough decline). And if history is a guide, we should expect a 10% decline in the S&P 500 about once a year, on average. The decline thus far, by comparison, has been shallow.
This all aligns with a broad market that is overly top-heavy with big tech stocks. The valuation models on Wall Street aren't nearly as friendly to the high growth-tech giants, when a higher interest rate (discount rate) is plugged in.
Thus, those stocks become vulnerable to a significant valuation adjustment in a higher interest rate outlook.
As we discussed Friday, we should expect the earnings calls to be heavy on inflation talk. And we should expect the conversation surrounding these calls to be about, what appears to be, success companies are having in passing along costs to consumers.
The banks will set the tone this week. We'll hear from JP Morgan on Wednesday. The other three of the big four banks will be on Thursday.
On the topic of "costs": The head of JP Morgan, Jamie Dimon, said today at a conference that consumer demand is "extraordinary," even in the face of the supply chain disruptions and higher prices. He says consumers are spending 20% more today than a year ago.
On the one hand, he's talking about the total dollar value of spending (which means there is, at least, a fair amount of higher prices represented in that statistic). But it also means that consumers have the confidence to spend. That's a big deal. That's underpinned by a higher savings rate and a job market where employees are in a position of strength to command higher wages.
So, a strong consumer should fuel plenty of positive talking points for the banks this week. In the case of JP Morgan (the biggest bank in the country), it has already been an embarrassment of riches, as they've beaten revenue and earnings every quarter coming out of the pandemic, with record profits in the first half of 2021.
Also remember, as we've discussed over the past year, the banks have a war chest of loan loss reserves (set aside in the depths of the pandemic) that they will continue to move to the bottom line at their discretion. That means they have a large inventory of positive earnings surprises they will present to us for several quarters to come. Add that to a (coming) rising interest rate environment, and the bank stocks are in the sweet spot.
We own the cheapest of the big four banks in our Billionaire's Portfolio. In fact, it's a double-weighted position. Become a member today (here), and get all of the details.
The big jobs report came in this morning. The payroll number was weaker than expected. That number gets a lot of attention. And with that, there was some debate over whether or not it would dissuade the Fed from "beginning the end" of QE, at their November meeting.
But there should be no debate. The unemployment rate is now below 5%. Wage growth came in last month at an annual run rate of over 7%. Both the August and July numbers for "jobs added" were revised UP. And if we look at the jobs report from ADP on Wednesday, the number was hot. With that, by this time next month, we'll probably find this payroll number reported today will have been revised higher too.
Bottom line: The Fed is managing against a mandate of full employment and price stability. They've nearly won the battle on employment and they are losing the battle on price stability. So, not only is it time to end emergency level policies, they should be farther along than they are in the process.
As we've discussed throughout the year, the Fed has positioned themselves to be behind the curve on inflation, which means they will be chasing it. And that means inflation will likely run hotter, maybe much hotter through next year.
On that note, third quarter earnings will kick into gear next week, when we hear from the big banks. We've already heard from 21 S&P 500 companies, and most are talking about inflation. They're talking about labor costs. They're talking about supply chain disruptions. They're talking about freight costs. They're talking about commodity costs. And they're talking about covid costs.
As we've discussed, while the supply chain bottlenecks will clear at some point, much of these costs are sticky, particularly labor and commodity costs.
With that, we should expect the conversation surrounding these earnings calls to turn to, "passing along costs." Are companies successfully passing these costs along to consumers? The answer seems to be yes.
That means wage inflation will have to keep pace with these rising costs (unlikely). Or quality of life goes down.
With the debt ceiling drama taking an intermission, and the anticipation of the strong jobs report coming tomorrow, global markets (and the global risk picture) were broadly positive today.
As we’ve discussed, the employment recovery has looked very good (at a 5.2% unemployment rate) — getting closer to the long-term average unemployment rate. Add to that, the unemployed in half of U.S. states have now lost additional federal unemployment pay, and should be moving back into the work force — likely to be represented in this data we’ll see tomorrow morning. That means we should see a good report/ lower unemployment.
And we know, not only has the headline inflation rate been running well north of the Fed’s target level, but the wage component in these jobs reports has been running hot. We don’t need to see it in a government report. We can see it all around us. Employers are short of labor. And employees are commanding a higher wage, and getting it.
Throughout the post-financial crisis era, when the Fed was trying to produce some inflationary pressures (to avert the deflation threat), what was the one piece that wasn’t materializing for them? Wage growth. Now we have it.
So while the supply chain disruptions will, at some point, abate. Higher wages will stick. That’s a tailwind for inflation.
Higher energy prices are driven by a structural supply shortage (not bottlenecks). That’s sticky. That’s a tailwind for inflation.
With the above in mind, the Fed’s dual mandate of price stability and full employment clearly doesn’t justify emergency level policies.
So, a strong report tomorrow will further validate the Fed’s plan to officially change-the-direction of monetary policy at their November 3rd meeting.
All of this said, if we look forward by a month or two, the question is: how will the Fed react if/when the unemployment starts to move back up, due to vaccine mandates? They may not taper for long. Â
In recent days, we’ve seen a persistent climb in energy prices — to new record highs by the day. Â
And we entered today with that burden of the building energy crisis, combining with a politician-imposed deadline on raising the debt ceiling.
With that double whammy, stocks were sniffing around the lows of this recent correction this morning.
But by the afternoon, stocks had bounced aggressively (almost 2%), thanks to some well placed promises.
On the energy front: After Dutch natural gas prices jumped 60% in two days, Russia said it would send record amounts of natural gas to Europe this year. That was liberally interpreted as a promise. Global energy prices dropped.
On the debt ceiling front: As the President was hosting a meeting with some of the biggest corporate and banking leaders, laying out the consequences of a debt default to the American public, the other side (the Republican Senate) stepped up and floated an offer that would extend the debt ceiling deadline to December. Stocks rallied.
Now, every time U.S. debt is brought into the crosshairs we can expect the politicians to leverage the situation, and to use every chance they have to posture in front of cameras, insulting our intelligence with scare/doom and gloom debt-default scenarios.
But in the post-global Financial Crisis and Pandemic era, we have plenty of visibility on this perceived disaster scenario. We’ve seen the movie before.
Keep in mind, when a potential default in Greece threatened to destabilize the world, the major economic powers of the world stepped-in, providing support for Europe — helping to finance their rescue facilities and support the euro.
The takeaway:Â Within this crisis era, they (the major economies of the world)Â are all on the same team.
Not only will foreigners not dump our Treasuries, they will buy our Treasuries.  In fact, even today, as this “default scenario” was being bandied about, the price of the 10-year Treasury was rising, as it did in the two debt ceiling dramas of the past ten years.
It all boils down to this: The world’s governments and central banks (led by the Fed) crossed the line in the sand, in response to the financial crisis. They all went all-in. They told us explicitly that they would do anything and everything to maintain stability and confidence in global markets. That hasn’t changed. In fact, the backstop powers have been wielded to a far greater extent in the pandemic response.
So, for perspective, a self-inflicted wound to the biggest economy in the world, that would destabilize global markets and threaten the global economic recovery, is highly unlikely (not going to happen). Â
We’ve been talking about the building energy crisis.Â
The melt up in energy prices continued today.  Crude oil broke $79. Coal was up 12%. And natural gas was up 9%. Again, this is just today.
The national average for gas prices was $2.18 a year ago. Today, it’s $3.20. And for the reasons we’ve discussed for the better part of the past year, crude oil prices are going higher from here, not lower. So is the price of gas.
That said, while the consumer is flushed with cash, and consumption has been running above trend levels, we should expect higher energy prices to start squeezing the consumer.
Add to that, we have a risk to the very healthy gains we’ve seen in the employment situation.
We’re starting to see early signals in New York, of layoffs and walkouts, driven by vaccine mandates. The biggest healthcare provider in New York fired 1.8% of it’s staff on Monday. And unlike the post-pandemic unemployment environment, these newly unemployed healthcare workers will, not only, not get a generous Federal unemployment check, they won’t qualify for state unemployment aid.
So we have higher prices, not just in energy, but practically all commodities and everyday consumption. And we now have prospects for rising unemployment.Â
This is a clear formula for damaging what has been record-healthy consumer balance sheets. And both components of this formula have been expressly manufactured by policies of the Biden White House. I suspect this will create enough economic pain over the coming weeks (maybe months) to get the $4.7 trillion of additional fiscal spending across the line.
The correction in stocks continues. We've been looking at this chart below, as our guide, following the break of the big uptrend.
This yellow trendline in the chart, represents the 40% climb in stocks from election day, on anticipation of continued easy money, and a massive fiscal spend to fund Biden's clean energy agenda.
But now the Fed has set expectations for a change in policy direction.
And the politicians on Capitol Hill are getting closer to firing of fiscal bazooka.
With that, we had a catalyst to trigger this correction.
And if history is our guide, we should expect some more pain, maybe something in the 10% neighborhood. Going back through almost 80 years of data, we have a 10% decline in stocks, on average, about once a year. The 200-day moving average (the purple line) now comes in at 9% below the record highs. I suspect we'll see that tested.
That said, while stocks were down today, commodities were UP. This is a clue.
Unlike many of the declines in stocks we've seen in the post-financial crisis decade, this decline is not about demand. It's about prices.
The media will continue to harp on the Chinese property market, the U.S. debt ceiling and related infighting on Capitol Hill. But this continues to look like the world is waking up to a materializing energy crisis.
Last week we looked at the storm that is brewing in global energy. The record prices are reflecting a combination of the war on fossil fuels, meeting supply chain bottlenecks and a ramping of global demand (coming out of the depths of the pandemic).
We looked at coal futures. This is up another 12% since we saw this chart last Thursday.
We looked at natural gas. This has tripled from the pandemic lows.
And global demand for natural gas and coal is now higher than pre-pandemic levels. Yet supply has been choked off by the global climate agenda.
So demand is turning to oil.
And guess who's back in the driver's seat in determining oil prices? OPEC. Not surprisingly, OPEC chose not to take measures to curb prices in a meeting today.
And with that, we have this chart in oil …
After the OPEC news, oil broke above the big $77 level, to seven year highs. As I've said, get ready for $100 oil.
The Fed was due to deliver a report on the viability of a central bank-backed digital currency (CBDC) in September. It's October 1st, and no report.
So, Powell was asked about his thoughts on a digital dollar in his latest post-FOMC press conference. He didn't take position either way, but said it would ultimately be a government-wide decision — i.e. the decision would lie with Congress.
We know that Congress has already held a hearing on the prospects of a digital dollar, back in June. It was led by Elizabeth Warren. She's in favor (so is the administration). So, it's safe to expect that the "government-wide decision" will be a "yes." It's coming. And Warren made it clear, in the hearing, that a central bank-backed digital dollar would "help drive out bogus digital private money (bitcoin, stablecoins, etc.)."
So, this has become maybe the existential threat to bitcoin.
But today, the private crypto market got some encouraging news. The BIS issued a report from a consortium of the top central banks in the world (including the Fed), that seemed to evaluate CBDCs in a world that coexisted with private cryptocurrency. Bitcoin jumped 10% on the news.
We will see if the stand-alone Fed report, which is supposedly coming soon, is as friendly. If so, the Democrat Congress that will be voting on the Fed Chair's renomination (in February) probably won't be too happy about it.
