The Banking Sector And Structural Risk
"Our overall results continue to benefit from a favorable credit environment, which we do not expect to continue. We continue to focus our business planning around a return to normal or even adverse credit conditions across all our businesses," - JP Morgan CEO Jamie Dimon in a recent press release.
I've written about the banking sector a handful of times in the last few months including the fact that the May top was the likely top in the Philadelphia Banking Index. While I offered up a possible marginal new high of approximately 116, we still have made no progress against the May top. In fact, we are marginally lower than the May top. Markets rising without the banking sector are very suspect. That isn't an opinion. That is as close to a fact as one will get.
If there was ever a time in the last thirty years to steer clear of financial institutions as investments, I believe today is that time. We have numerous long wave forces combining to create a potentially destructive cycle for said investments. While I realize banks are considered a decent value play because they are sporting dividends of 3-4%, one must realize banks are not defensive investments. One more time. Banks have never been and will never be defensive investments. Because I firmly believe man is inherently prone to foolish endeavors, banks and consumer financial institutions are in need of special regulation to protect our savings and investments. Time and again banks have proven their perfect fallibility by practicing unwise risk management, investing in unsound schemes and making foolish decisions with our savings. In prior cycles they have made unwise investments in energy, unwise investments in real estate and unwise investments in business on grand scales. And, since bankers also exhibit group-think behavior, they tend to all make the wrong decisions at the same time thus increasing the potential and magnitude of a "mess". In fact, the reason we have a central bank is in large part to be the rock we can count on when bankers make foolish decisions and jeopardize our savings. While central banks should really be proactively keeping banks from getting into unsound investments in the first place, central bankers are prone to fallibility as well.
While some people believe the 2000-2002 bear market was the worst in history, that simply is not the case. It could have been the worst bear market in history except for central banker attempts to stave off disaster by fueling credit expansion which, when undertaken in a business recessionary cycle, is allocated into the consumer sectors. So, what we have experienced is likely an equally serious equity bubble in the consumer sectors developing from 2000-2006.
Economics seems to be a form of voodoo for many but it's really a very simple social science. I like to use visualization as a method of explanation to help people understand a concept. The cycle pre-2000 was a positive expansionary cycle. That means the consumer sector and the business sector were positively synchronized. Using an ocean wave to explain the concept, we had two very powerful waves form to create a double sized positive wave. Post-2000, left unattended, we would have had a synchronized downturn where both business and the consumer sectors combined to create cumulative wave of destructive or cleansing power of the imbalances created over a long wave expansionary cycle. Instead, global central bankers injected significant liquidity and credit into the cycle. As economic theory would substantiate, that investment would be directed into the consumer sector as I alluded to in a prior post. What ended up happening post-2000 was we had two waves colliding. A negative business cycle wave and a positive consumer cycle wave from 2000-2006. Think of two waves moving in opposite directions on a collision course. Generally, these two waves would cancel each other out as they collided. But, with the consumer sector being the larger of the two, we experienced positive growth but stagnant wages as we would expect in a business driven recession. What most people don't realize is that we are still in a business recession but we are in a consumer expansion.
So, just as happened in 2000 at the end of a positive expansionary cycle in business, we are likely entering an end to an approximately seventeen year positive consumer cycle. Thus, this cycle has the potential for both the ongoing negative business cycle to combine with the start of a negative consumer cycle to create an additive negative wave. In other words, the purging cycle. A cycle with the potential for tremendous capital destruction. ie, Don't expect to see consumer stocks bucking the downward trend as we saw post-2000.
To me it's rather hilarious to read of the Intel, Microsoft and Dell bashing so prevalent. This shows a clear lack of understanding of basic economics and why cycles occur. It is not a coincidence I have written positive posts on these three companies in the last few months while being very dour on stocks in general. The next positive expansionary cycle will be led by business not by consumers. These three companies will be amongst the leaders where capital will be heavily allocated both from a business perspective and an equity market perspective. I do not like any of these companies as investments today but it is no surprise they are rising contrary to those dumbfounded that these dead companies are acting positively. In fact, since writing about these three companies, I believe all three have been three of the best investments on Wall Street. Before my musings, they were the biggest dogs on Wall Street. It isn't because I'm clairvoyant or brilliant. It is because I have a relatively strong grasp of both short and long wave cycle theory and most on Wall Street don't even acknowledge long wave cycles exist. Or, at least the ones trotted out for public consumption don't. Many do but you don't get the luxury of their opinions. They are too busy setting strategy and making billions. Might I add in summary that those who are buying these three companies right here are betting the Fed will save the economy and that positive expansionary cycle is right around the corner. They are likely very wrong.
So, you may argue that AMD or Apple are also business driven stocks and they have flourished this cycle. To the contrary, AMD is a consumer oriented company. Their desktop & mobile solutions have not cracked the corporate market one iota. Yet. Ditto with Apple which has nearly zero penetration into business. So, if you understood the current cycle, you would be long AMD & Apple not Intel. Or, long AMD or Apple and short Intel as a pairs trade post the technical impulse rally in semiconductors in 2003.
That AMD is reflective of the consumer and is showing continued weakness is not a positive sign for the general economy. One might argue as I had written prior that Intel's new products are hurting AMD but the reality is more likely that AMD weakness is reflective of a negative consumer cycle starting soon. In fact, quietly AMD is headed back to retest its post-May selloff lows as Jim Cramer and others tell you to load up on semiconductors. While I came pretty close to calling the exact peak in Apple then the subsequent rally, I would be extremely surprised if we would not start to see Apple develop sustained weakness as it retests its prior highs. My work shows continued underlying weakness in Apple regardless of this retracement rally.
In summary, the banking sector poses significant risk as we have the potential to enter a cumulative downward cycle. We are likely entering a cycle similar to 1974 or the mid 1930s. I'm not calling for another Great Depression but rather the synchronization of negative cycles. We may have a mild recession or we may have a situation where something more significant develops. There are simply too many constantly changing variables to determine the global economic future. I prefer not to hold through such a cycle without any clarity of where we go from here. In a positive or mixed cycle slow down, I would allocate capital to defensive sectors and sectors I deemed the beneficiary of future liquidity injections but not here. I'd rather garner a guaranteed 5% than to take undue risk.
The markets are shunning risk right now. So, do you want to heed the words of Jamie Dimon, the action of the banking sector and the action of the Generals or are you ready to declare the mid-cycle slow down "beaten" as many on Wall Street and the media would have you believe?
Investing is not gambling. Risk management is the key to your long term success.
I've written about the banking sector a handful of times in the last few months including the fact that the May top was the likely top in the Philadelphia Banking Index. While I offered up a possible marginal new high of approximately 116, we still have made no progress against the May top. In fact, we are marginally lower than the May top. Markets rising without the banking sector are very suspect. That isn't an opinion. That is as close to a fact as one will get.
If there was ever a time in the last thirty years to steer clear of financial institutions as investments, I believe today is that time. We have numerous long wave forces combining to create a potentially destructive cycle for said investments. While I realize banks are considered a decent value play because they are sporting dividends of 3-4%, one must realize banks are not defensive investments. One more time. Banks have never been and will never be defensive investments. Because I firmly believe man is inherently prone to foolish endeavors, banks and consumer financial institutions are in need of special regulation to protect our savings and investments. Time and again banks have proven their perfect fallibility by practicing unwise risk management, investing in unsound schemes and making foolish decisions with our savings. In prior cycles they have made unwise investments in energy, unwise investments in real estate and unwise investments in business on grand scales. And, since bankers also exhibit group-think behavior, they tend to all make the wrong decisions at the same time thus increasing the potential and magnitude of a "mess". In fact, the reason we have a central bank is in large part to be the rock we can count on when bankers make foolish decisions and jeopardize our savings. While central banks should really be proactively keeping banks from getting into unsound investments in the first place, central bankers are prone to fallibility as well.
While some people believe the 2000-2002 bear market was the worst in history, that simply is not the case. It could have been the worst bear market in history except for central banker attempts to stave off disaster by fueling credit expansion which, when undertaken in a business recessionary cycle, is allocated into the consumer sectors. So, what we have experienced is likely an equally serious equity bubble in the consumer sectors developing from 2000-2006.
Economics seems to be a form of voodoo for many but it's really a very simple social science. I like to use visualization as a method of explanation to help people understand a concept. The cycle pre-2000 was a positive expansionary cycle. That means the consumer sector and the business sector were positively synchronized. Using an ocean wave to explain the concept, we had two very powerful waves form to create a double sized positive wave. Post-2000, left unattended, we would have had a synchronized downturn where both business and the consumer sectors combined to create cumulative wave of destructive or cleansing power of the imbalances created over a long wave expansionary cycle. Instead, global central bankers injected significant liquidity and credit into the cycle. As economic theory would substantiate, that investment would be directed into the consumer sector as I alluded to in a prior post. What ended up happening post-2000 was we had two waves colliding. A negative business cycle wave and a positive consumer cycle wave from 2000-2006. Think of two waves moving in opposite directions on a collision course. Generally, these two waves would cancel each other out as they collided. But, with the consumer sector being the larger of the two, we experienced positive growth but stagnant wages as we would expect in a business driven recession. What most people don't realize is that we are still in a business recession but we are in a consumer expansion.
So, just as happened in 2000 at the end of a positive expansionary cycle in business, we are likely entering an end to an approximately seventeen year positive consumer cycle. Thus, this cycle has the potential for both the ongoing negative business cycle to combine with the start of a negative consumer cycle to create an additive negative wave. In other words, the purging cycle. A cycle with the potential for tremendous capital destruction. ie, Don't expect to see consumer stocks bucking the downward trend as we saw post-2000.
To me it's rather hilarious to read of the Intel, Microsoft and Dell bashing so prevalent. This shows a clear lack of understanding of basic economics and why cycles occur. It is not a coincidence I have written positive posts on these three companies in the last few months while being very dour on stocks in general. The next positive expansionary cycle will be led by business not by consumers. These three companies will be amongst the leaders where capital will be heavily allocated both from a business perspective and an equity market perspective. I do not like any of these companies as investments today but it is no surprise they are rising contrary to those dumbfounded that these dead companies are acting positively. In fact, since writing about these three companies, I believe all three have been three of the best investments on Wall Street. Before my musings, they were the biggest dogs on Wall Street. It isn't because I'm clairvoyant or brilliant. It is because I have a relatively strong grasp of both short and long wave cycle theory and most on Wall Street don't even acknowledge long wave cycles exist. Or, at least the ones trotted out for public consumption don't. Many do but you don't get the luxury of their opinions. They are too busy setting strategy and making billions. Might I add in summary that those who are buying these three companies right here are betting the Fed will save the economy and that positive expansionary cycle is right around the corner. They are likely very wrong.
So, you may argue that AMD or Apple are also business driven stocks and they have flourished this cycle. To the contrary, AMD is a consumer oriented company. Their desktop & mobile solutions have not cracked the corporate market one iota. Yet. Ditto with Apple which has nearly zero penetration into business. So, if you understood the current cycle, you would be long AMD & Apple not Intel. Or, long AMD or Apple and short Intel as a pairs trade post the technical impulse rally in semiconductors in 2003.
That AMD is reflective of the consumer and is showing continued weakness is not a positive sign for the general economy. One might argue as I had written prior that Intel's new products are hurting AMD but the reality is more likely that AMD weakness is reflective of a negative consumer cycle starting soon. In fact, quietly AMD is headed back to retest its post-May selloff lows as Jim Cramer and others tell you to load up on semiconductors. While I came pretty close to calling the exact peak in Apple then the subsequent rally, I would be extremely surprised if we would not start to see Apple develop sustained weakness as it retests its prior highs. My work shows continued underlying weakness in Apple regardless of this retracement rally.
In summary, the banking sector poses significant risk as we have the potential to enter a cumulative downward cycle. We are likely entering a cycle similar to 1974 or the mid 1930s. I'm not calling for another Great Depression but rather the synchronization of negative cycles. We may have a mild recession or we may have a situation where something more significant develops. There are simply too many constantly changing variables to determine the global economic future. I prefer not to hold through such a cycle without any clarity of where we go from here. In a positive or mixed cycle slow down, I would allocate capital to defensive sectors and sectors I deemed the beneficiary of future liquidity injections but not here. I'd rather garner a guaranteed 5% than to take undue risk.
The markets are shunning risk right now. So, do you want to heed the words of Jamie Dimon, the action of the banking sector and the action of the Generals or are you ready to declare the mid-cycle slow down "beaten" as many on Wall Street and the media would have you believe?
Investing is not gambling. Risk management is the key to your long term success.
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