Category: Economy

Analysis of the global economy

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Bank heavyweight earnings slip

Thursday was a big day for earnings releases, with two bank heavyweights reporting first-quarter (Q1) 2016 earnings.

Bank of America (BAC)

Bank of America reported a 19 percent fall in earnings per share ($0.21) compared to the first quarter of last year ($0.26). The fall was largely attributable to a drop in investment banking and trading profits. Provision for credit losses increased 30% for the quarter, to $997 million.

Tier 1 Capital (CET1) improved to 11.6% (Q1 2015: 11.1%) of risk-weighted assets, while Leverage (SLR) improved to 6.8% (Q1 2015: 6.4%).

The dividend was held at 5 cents (Q1 2015: 5 cents), increasing the payout ratio to a modest 24%, from 19% in Q1 2015.

BAC is in a primary down-trend, having broken primary support at $15. Long-term Momentum below zero confirms. Expect a rally to test resistance at $15 but this is likely to hold and respect would warn of another decline, with a target of $9*.

Bank of America (BAC)

* Target calculation: 12 – ( 15 – 12 ) = 9

Wells Fargo (WFC)

Wells Fargo reported a 5 percent fall in (diluted) earnings per share ($0.99) compared to the first quarter of last year ($1.04). Provision for credit losses increased 78% for the quarter, to $1.09 billion, primarily due to exposure to the Oil & Gas sector.

Tier 1 Capital (CET1) improved to 10.6% (Q1 2015: 10.5%) of risk-weighted assets. No leverage ratio was provided..

The dividend of 37.5 cents is up on Q1 2015 dividend of 35 cents, increasing the payout ratio to 38% from 34% in Q1 2015.

WFC is in a primary down-trend, having broken primary support at $48. Long-term Momentum below zero confirms. Expect a rally to the descending trendline but respect is likely and reversal below $48 would warn of another decline, with a target of $40*.

Wells Fargo (WFC)

* Target calculation: 48 – ( 56 – 48 ) = 40

So far we have had three heavyweights, JPM, BAC and WFC all report similar performance: declining earnings per share despite deep cuts in non-interest expenses, partly attributable to rising provisions for credit losses.

Citigroup (C) is due to report Friday 11:00 am EST.

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JP Morgan earnings dip but stock rallies

First of the financial heavyweights to report first-quarter (Q1) earnings this week, JP Morgan (JPM) reported a 7 percent fall in earnings per share ($1.36) compared to the first quarter of last year ($1.46). The fall was largely attributable to a 90 percent increase in provision for credit losses for the quarter, to $1.8 billion, primarily from a sharp increase in net charge-offs in the Consumer division but also exposure to Oil & Gas and Metals & Mining in Investment Banking.

Tier 1 Capital (CET1) improved to 11.8% (Q1 2015: 10.7%) of risk-weighted assets, while Leverage (SLR) improved to 6.6% (Q1 2015: 5.7%).

The dividend was held at 44 cents (Q1 2015: 40 cents), increasing the payout ratio to a modest 32% from 27% in Q1 2015.

The monthly chart shows long-term Momentum is slowing, with JPM forming a broad top above $54. Declining peaks since August 2015 warn of a primary down-trend and breach of $54 would confirm, offering a target of $40*.

JP Morgan Chase

* Target calculation: 55 – ( 70 – 55 ) = 40

The market responded well to ‘positive’ news that JPM beat its earnings estimate, boosting the stock by 4.6%. This is a game we will see a lot more of this year: give really low guidance if you expect a bad quarter. When the result comes out, the gullible will focus on the fact that you beat your estimate rather than that your earnings are falling. This chart from Zero Hedge shows the rising percentage of companies guiding next quarter earnings below consensus:
Earnings Guidance

Don’t be mis-led by the latest ‘froth’. The reality for the banking sector is net interest margins are near record lows and credit losses are rising.

Major US Banks Net Interest Margins

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Low interest rates and secular stagnation

Interesting observation by Pierre-Olivier Gourinchas, a research associate at the NBER:

In recent theoretical work, Caballero, Farhi, and I show that the safe-asset scarcity mutates at the ZLB [Zero Lower Bound], from a benign phenomenon that depresses risk-free rates to a malign one where interest rates cannot equilibrate asset markets any longer, leading to a global recession. The reason is that the decline in output reduces net-asset demand more than asset supply. Hence our analysis predicts the emergence of potentially persistent global-liquidity traps, a situation that actually exists in most of the advanced economies today.

…..our results point to a modern — and more sinister — version of the Triffin dilemma. As the world economy grows faster than that of the U.S., so does the global demand for safe assets relative to their supply. This depresses global interest rates and could push the global economy into a persistent ZLB environment, a form of secular stagnation.

Source: The Structure of the International Monetary System | NBER

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APRA waves wet lettuce at bank offshore funding | MacroBusiness

From Leith van Onselen at Macrobusiness:

…..the banks’ reliance on offshore funding hit an unprecedented 54% of GDP in the December quarter:

As always, the key risk is that the banks’ ability to continue borrowing from offshore rests with foreigners’ willingness to continue extending them credit. This willingness will be tested in the event that Australia’s sovereign credit rating is downgraded (automatically downgrading the banks’ credit ratings), there is another global shock, or a sharp deterioration in the Australian economy (raising Australia’s risk premia).

The Federal Budget, too, is now hostage to the banks’ offshore borrowing binge as it cannot borrow to spend on infrastructure or other initiatives for fear that Australia will lose its AAA credit rating, potentially leading to an unraveling of the private debt bubble created by Australia’s banks.

That APRA could stand by and allow the banks’ to borrow externally like drunken sailors is a hallmark of regulatory failure.

One in four dollars of bank assets is funded by offshore borrowing. A precarious position even for a stable economy (like Ireland?), let alone one hitched to the boom and bust commodity cycle. Smacks of moral hazard by the banks.

Source: APRA waves wet lettuce at bank offshore funding – MacroBusiness

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Headmaster Turnbull takes cane to banks

Elizabeth Knight quotes prime minister Malcolm Turnbull speaking at Westpac’s 199th birthday lunch:

Meanwhile Turnbull – himself a former head of the Australian chapter of Goldman Sachs – told those attending the Westpac lunch that bank culture must shift from one that traditionally had been all about profit to one that took into account broader social responsibility.

Remuneration and promotion cannot any longer be based solely on direct financial contribution to the bottom line.

While bank bosses have been talking the same kind of talk for a while now, the growing number of instances where the behaviour of the banks had fallen short as a result of the drive to increase profit (and personal bonuses derived from making returns) are becoming harder to explain away using the excuse of a few bad apples.

“We expect our bankers to have higher standards, we expect them always, rigorously, to put their customers’ interests first – to deal with their depositors and their borrowers, with those they advise and those with whom they transact in precisely the same way they would have them deal with them,” he said.

Turnbull has hit on a key risk area for banks: remuneration structures that reward short-term profit objectives promote a risk-taking culture. Bank deals often look impressive at the start only to sour later. Incentives that encourage employee share purchases align staff interests with those of shareholders — a prudent, long-term outlook — while share options and bonus schemes encourage a short-term focus, aggressive risk-taking and divisional rivalry that can damage long-term value.

APRA may consider remuneration structures as outside their risk management ambit but it is time for a re-think. Toxic management culture is the biggest risk of all.

“Only when the tide goes out do you discover who’s been swimming naked.” ~ Warren Buffett

Source: Headmaster Malcolm Turnbull takes cane to banks leaving Westpac management ginger

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RBA leaves official cash rate at 2pc

Jens Meyer quotes RBA governor Glenn Stevens:

While the decision to keep rates unchanged was widely expected, analysts were speculating that the governor would show some concern about the recent steep rise in the Australian dollar’s exchange rate, which gained nearly 12 per cent from its January lows to a peak of US77.23¢ last week.

Mr Stevens duly added a paragraph to this month’s statement, noting that the currency had appreciated “somewhat”.

“In part, this [the recent rise] reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role,” he said, referring to recent monetary easing by other central banks including the Bank of Japan and the European Central Bank, as well as the decision by the US Federal Reserve to reduce the pace of interest rate hikes.

“Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy,” he added.

But anyone hoping for a stronger “jawbone” was disappointed and the Australian dollar shot up by about half a cent to the day’s high of US76.32¢, before falling back in late trade to around US76¢.

Central banks around the globe are destabilizing financial markets and the RBA responds with a polite acknowledgement at the end of its statement. Someone please tell the governor: If you want to run with the big dogs, you’ve got to learn to pee high.

Source: RBA leaves official cash rate at 2pc

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Megalogenis: Australian Panic! | MacroBusiness

From Unconventional Economist at Macrobusiness:

…..George is back, this time with The Australian Panic in a new Quarterly Essay:

The Australian Panic

In this urgent essay, George Megalogenis argues that Australia risks becoming globalisation’s next and most unnecessary victim. The next shock, whenever it comes, will find us with our economic guard down, and a political system that has shredded its authority. Megalogenis outlines the challenge for Malcolm Turnbull and his government. Our tax system is unfair and we have failed to invest in infrastructure and education. Both sides of politics are clinging defensively to an old model because it tells them a reassuring story of Australian success. But that model has been exhausted by capitalism’s extended crisis and the end of the mining boom. Trusting to the market has left us with gridlocked cities, growing inequality and a corporate sector that feels no obligation to pay tax. It is time to redraw the line between market and state.

Balancing Act is a passionate look at the politics of change and renewal, and a bold call for active government. It took World War II to provide the energy and focus for the reconstruction that laid the foundation for modern Australia. Will it take another crisis to prompt a new reconstruction?

I think George has it right this time.

Source: Megalogenis: From Australian Moment to Australian Panic! – MacroBusiness

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Private health insurance fails to deliver

From Leith van Onselen at Macrobusiness:

The high financial overhead of private insurance in Australia means that only 84 cents in every dollar collected by private insurers is returned as benefits, with the rest going to administrative costs and corporate profits. By contrast, Medicare returns 94 cents in the dollar, even after the cost of tax collection is taken into account. In the United States, which is highly dependent on private insurance, only 69 cents in the dollar are returned as payment for health services.

More importantly, competing private insurers have less ability to control prices demanded by powerful service providers. If one insurer tries to bargain hard with hospitals to keep prices down, the hospitals simply choose to do business with another insurer.

By contrast a single national insurer has the market power to push down costs and improve utilisation. The below chart of health costs across 18 OECD countries highlights this point: single national insurers provide cheaper (and often better) health care than systems heavily reliant on private health insurance:

This is an argument for abandoning private health insurance, not private health care. Experience of Italy’s Lombardy region suggests a level-playing field, with open competition between public and private health care providers, delivers superior results. From Margherita Stancati at WSJ online:

Like other European countries, Italy offers universal health-care coverage backed by the state. Italians can go to a public hospital, for example, without involving an insurance company. The patients are charged a small co-pay, but most of the bill is paid by the government. As a result, the great majority of Italians don’t bother to buy private health insurance unless they want to seek treatment from private doctors or hospitals, which are relatively few.

Offering guaranteed reimbursements to public hospitals, though, took away the hospitals’ incentive to improve service or rein in costs. Inefficiencies were rampant as a result, and the quality of Italy’s public health care suffered for years. Months-long waiting lists became the norm for nonemergency procedures—even heart surgery—in most of the country.

Big changes came in 1997, when Italy’s national government decentralized the country’s health-care system, giving the regions control over the public money that goes to hospitals within their own borders…..

In much of the country, regions have continued to use the standards of care and reimbursement rates recommended by Rome. Some also give preferential treatment to public hospitals, making it more difficult for private hospitals to qualify for public funds.

Lombardy, by contrast, has increased its quality standards, set its own reimbursement rates and, most important, put public and private hospitals on an equal footing by making each equally eligible for public funds. If a hospital meets the quality standards and charges the accepted reimbursement rate, it qualifies. Patients are free to choose between state-run and publicly funded private hospitals at no extra cost. Their co-pay is the same in either case. As a result, public and many private hospitals in Lombardy compete directly for patients and funds.

…..Around 30% of hospital care in Lombardy is private now—more than anywhere else in Italy. And service in both the private and public sector has improved.

State hospitals have improved their service levels while private hospitals have lowered costs in response to the increased competition. A win for all …..except private health insurers.

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APRA gives the RBA some wiggle room | Business Spectator

Robert Gottliebsen predicts further rate cuts from the RBA:

Given that Australian interest rates are higher than other countries of similar standing, money is now flowing Down Under which works to boost the currency and some are forecasting that the exchange rate could rise as high as US80c.

Thanks to APRA, the Reserve Bank can now attack the currency with lower rates without the risk of putting a rocket under house prices.

Source: APRA gives the RBA some wiggle room | Business Spectator

Hat tip to David Llewellyn-Smith at Macrobusiness

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