Take It To The Bank

16 June 2022
Market Insights

We are currently living through a period of tremendous economic uncertainty. We often hear comparisons to the high inflation rates of the 1970s, the extreme market valuations of technology and startup companies in the late 1990s or the unhealthy build-up of debt in the early 2000s. We would agree that there seem to be correlations to be drawn and lessons to be learned from all three of those time periods. However, what is unique, and puts us in unchartered waters, is that we seem to be experiencing the worse symptoms of all three historical periods at the same time.

What is the best course of action based on the facts at hand? How do we formulate a strategy for making good decisions in this difficult environment? One approach is to take cues from the best and brightest on Wall Street. Who better to assess the state of the global economy and provide potential warnings of the risks that may lay ahead than the CEOs of the largest banks in the world? Fortunately, many of the top bank executives make regular public appearances, so it is not difficult to get their perspective. At a minimum, they provide a detailed assessment of their economic outlook for businesses and consumers every quarter during their earnings calls with analysts and investors. In an effort to gain some insight, we have spent time combing through the call transcripts and have identified a few comments made from the leaders of Wall Street titans like JP Morgan Chase, Citigroup, Wells Fargo and Bank of America that we believe are instructive. Here is a sample of what we found:

Bank of America – CEO

“Currently we are looking for GDP growth around 3% in H2.”
“We see that as healthy growth but remain a little concerned about domestic consumption and spending…..however, given our business momentum in the first six months of the year, we think we are well-positioned going into H2 with additional upside (next year)”

Citigroup – CEO

“So in sum, we’re making very good progress. I feel very good about what we’re doing”
“We have strong revenue growth.”
“International markets are very, very robust and that’s where our future growth is coming.”
“Now, we still have a lot to do, but that lot to do is really opportunities for us, and I am more and more confident of the path we’re on.”

JP Morgan Chase – CEO

“(There are) risks in the investment bank that are getting heightened scrutiny today, but the backdrop against that is we have a very strong global economy.”
“Corporations are strong. There is full employment, growing employment, full employment in the US.”
“This is not a recession.”

Our takeaway from these comments is that the environment is mixed, but overall, we are on a positive trajectory. The bank chiefs all seem to hedge their comments in an effort to temper expectations, but there is certainly no dire predictions of deep recessions or massive value destruction. The fact that the chief executives at three of the largest financial institutions in the world are all relatively upbeat about the future should give the rest of us some comfort…….or should it? Reading between the lines, one may make the case that the bank CEOs comments are all pretty general and there seems to be more to the story than what they are letting on. The biggest issue that we, at JPS Financial, have with the comments is that they all occurred in July 2007!

You may recall that the global economy, the stock market and especially bank stocks did not do too well in the second half of 2007 and 2008. Below, we have provided a stock performance chart for each of the three banks whose CEOs assured investors that everything would be alright. The charts begin from the date of the above quotes and end at the market low in March of 2009.

Ken Lewis, Bank of America CEO

Quote on 7/19/07 => “We are well positioned for H2 2007 with additional upside in 2008”
Stock performance from 7/19/07 to 3/6/2009 => - 93.63%

Charles Prince, Citigroup CEO

Quote on 7/20/2007 => “I feel very good about what we’re doing.”
Stock performance from 7/20/2007 to 3/5/2009 = > - 98.01%

James Dimon, JP Morgan Chase CEO

Quote on 7/18/2007 => “This is not a recession.”
Stock performance from 7/18/2007 to 3/9/2009 => - 67.47%

Hindsight is always 20/20. Looking back, it is was an obvious mistake for any investor who took the optimistic comments from the bank CEOs in the summer of 2007 at face value. An important point to make is that it was not just mom and pop retail investors who were misled. Rather, the majority of professional stock analysts who were following these bank stocks in the summer of 2007 had them rated as a “Buy” (JPM – 67% buy rating, C – 71% buy rating, BAC – 60% buy rating).

What lessons can we glean from this historical observation? First and foremost, we should not take optimistic comments from CEOs of public companies at face value. Public company CEOs have different priorities than outside investors. Investors want to know as much as they possibly can about the future viability and growth prospects of a particular company to make an investment decision. The CEOs main objective, on the other hand, is to attain the lowest possible cost of capital. By shining a positive light on every set of circumstances, CEOs are likely to achieve a lower interest cost on their company’s debt and a higher price for their stock. Most executives accomplish this well within the scope of the law and SEC regulations. It is not that they are trying to deceive or that they are bad people. Many would argue that being the biggest cheerleader for their company is an important part of any CEO’s job. They simply have different objectives than outsiders, so as investors we must be aware of how the game is played.

One might conclude that, since CEOs are going to be optimistic no matter what, investors should completely ignore what they say. We believe a more nuanced approach is appropriate. While it is true that CEOs are likely to be positive no matter what, there seems to be a higher degree of hedging in their language when the environment is less certain. A degree of hedging can clearly be detected looking back on the bank CEOs comments in 2007. Based on that understanding, where do we stand today? Here are some quotes from big bank CEOs in April of 2022, following Q1 earnings announcements.

Brian Moynihan, Bank of America CEO– 4/18/2022

“Could a slowdown in the economy happen? Perhaps. But right now, the size of the economy is bigger than pre-pandemic levels, consumer spending remains strong, unemployment low and wages are rising.”

William Scharf, Wells Fargo CEO – 4/14/2022

“The health of our consumer and businesses so far has remained strong, though we’re entering a period of uncertainty.”

Jamie Dimon, JP Morgan CEO – 5/23/2022

“We have a strong US economy fueled by monetary and fiscal stimulus that you’ve never seen before.”
“So it is a different strong economy and the consumer is in very good shape even today.”

Sound familiar? Can you detect an outlook that is generally positive, but loaded with a variety of potential outs if the environment turns south? We certainly think so. Therefore, we believe it is necessary to combine the oracles’ reading of the tea leaves with what their banks are actually doing. In the words of Emerson, “what you do speaks so loudly I cannot hear what you say.” Along those

lines, we noticed an important action in the Q1 2022 earnings announcement from JP Morgan Chase with Jamie Dimon at the helm. Large banks are required to set aside reserves if they believe a portion of their NPLs (non-performing loans) will not be collected. Loan losses trending upward have historically been a good indicator that economic and credit conditions are worsening. Unfortunately, there seems to be a fair amount of subjectivity in terms of when and to what degree banks set aside funds for potential losses, especially since the banks must realize a negative impact on current earnings to do so. Adding to loss reserves detracts from reported income in the relevant quarter. Ultimately, if it turns out that the bank does a better job of collecting on those loans than originally anticipated, and doesn’t need some of the loss reserves that had previously been set aside, the bank can then release a portion of the reserves. Releasing a portion of loss reserves is treated as a positive addition to the bank’s earnings when it occurs. That accounting provision has been a boon for big banks all through 2021 as they released tens of billions of loss reserves that had previously been set aside in 2020 but not needed due to the enormous fiscal and monetary stimulus programs. The surge in income that resulted from releasing loss reserves propelled the S&P Bank index up over 140% from the 2020 pandemic lows.

What we find interesting, is that in Q1 of 2022, JP Morgan Chase decided to reverse course. They actually added $900 million to loan loss reserves in Q1 when most other big banks continued to release reserves and reap the benefits on their income statement. In comparison, Wells Fargo released about $1 billion and Bank of America released about $300 million. The nominal amount of $900 million is not a big deal to JP Morgan Chase which has total assets on its balance sheet of just under $4 trillion dollars. What is important, though, is the directional shift and the disparity between JP Morgan and the other banks. The CEO of JP Morgan, Jamie Dimon, is the only big Wall Street bank CEO to survive the Great Financial Crisis. Did he learn from his past experience? Should we pay more attention to his actions as opposed to his somewhat reassuring comment about a “different strong economy?”

History has proven that it is not uncommon for the leaders of the largest financial institutions in the world to know more than they are letting on. In fairness to them, CEOs of all public companies make a habit of downplaying negative news while they talk about “how full the glass is.” Based on everything that we have studied, our recommendation is to remain cautious. We can never be sure of what the future holds. However, one thing we are confident in is that you cannot look to the bank CEOs for an accurate assessment of a bad or worst-case scenario. If they believe there is a chance that we are headed for a severe recession, we are certain they will not admit it publicly until it is so obvious that it can no longer be denied. You can take that to the bank.

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