Wednesday, July 27, 2016

DB: Things are getting serious

Well a few days ago I wrote how some of Europe's core bank could eventually face problems because of Southern Europe's bank massive bad loan holdings.  Turns out Deutsche Bank's problem are not only related to Southern bank's possible failure, but to its core activities.

DB stands in a very strange place, it ressembles Mellon bank rather than Citibank, both institutions were considered "money center banks" in the early 1980s.  However, Citi had a massive retail network, Mellon bank, had Pittsburgh -- by then the dying centre of what would eventually become known as the rust belt!  For most foreigners the surprise when visiting Germany is the incredible number of retail banks -- there are hundreds across the country.  The result of this large number of independent banks is that no financial institution controls much of  the domestic deposit base.  DB's accounts for 3.5% of Germany's total deposit base (they get another 4% from Postbank -- but they are selling that).  Compare that to Canada where the six largest institutions account fo nearly 90% of all retail deposits. 

Profits for 2015/16 were off by 98% -- and there was not a single cause, weakness in the retail banking, weakness in IB weakness in debt capital market (I know IB is part of that).  Overall weakness everywhere -- DB is the most European of all European banks, because its home base is not really the centre of its economic activities -- that is London's job. The overall weakness of Europe impacts it the most -- it doesn't have a home base to provide secured income. Therefore, we should expect weak results from the other players -- after all Citibank's recent quarterly results were not great, in fact, they were only perceived as being good, because the bank had indicated to analysts that their performance would be even worse!  Call DB the canary in the coal mine.

This is very worrying; I am not a fan of DB, although some very good friends work there, but together with Caterpillar, it represents one of the best barometers of Europe's economic health.  The verdict is not very good; Caterpillar announced terrible results a few weeks back -- yellow equipment is often at the source of economic growth (building things) where demand for trucks, diggers and other assorted equipment falls (off a cliff in this case) these are worrying signs for GDP growth.

I've been predicting economic collapse for years!  eventually, I will be right...seriously, I see the worse in people and in markets -- not an unusual trait for a worker in the financial industry.  In reality had I invested in stocks and bonds over the past 8 years (stocks in particular) I would have done great! Actually, virtually all asset class did well over the past 8 years -- the only exception is Private Equity and hedge fund that in general did poorly.  Credit expansion lifts all boats and hedging can become nearly impossible.  Over the past 8 years interest rates have continued their downward spiral -- even in some cases going negative (Germany 50y bond and Switzerland 30y bond).  Buying the S&P500 on the day of Barack Obama's inauguration on January 20th, 2009 at 826 you would have made a gain of 262%, off your initial investment -- excluding dividend (about 1.5% p.a.).  For investors the past 8 years have been a golden age of return  with a 12.8% IRR over the period.  Clear sign that the GOP talked complete trash for 8 years.  BTW if you invested in the S&P500 as a Canadian... well the CAD went from 1.07 to 0.7 over the past few years... That would have made the investment even better (somewhere in the 24% range).

The US market is now looking very "topish" (its near its all time high -- last week) both in total and relatively -- the market p/e stands at 25x -- which is high (the average is 15x, the mean 14x), and interest rates are not to blame here (there were very long periods in the 50s and 60s where interest rates were very low).  The reason for the weariness is the quality of earnings and how the high prices have been achieved.  First, above and bellow the line games are reached a new level (e.g. losses are extraordinary and profits are ordinary income), companies have incentivised their CEO teams to aim for higher stock prices -- so stock buybacks have been the name of the game for several years now, which makes sense, because if stock generate 12% return and debt -- with deductible interests is costing 4/5% the choice is so obvious it's to make you cry. 

Europe, well DB is a good argument that things in Europe are degenerating; Brexit, Turkey, further terrorist attempts (and unfortunate successes) will put the breaks to Europe.  Again it my be my own views, but Greece is still not fixed, the situation for Italian banks is still getting worse with no will or capital to address the situation.  There is no doubt that Britain will slow, already places like Luxemburg are pushing to replace the city (its not a terrible place).  In fact, Europe is stagnant and has been for years -- unemployment (especially youth) is damaging the long term economic growth prospect.  The power of entrenched rights is killing innovation, as the stake holders protect their turf with the accord of their political leaders.

Ok, I will channel my "investment advisor mantra":  All is well, things will turn out fine, invest invest invest!

Note:  No position on DB or CAT.


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