Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.
Talk about a case of cognitive dissonance. I have spent the last 12 months listening to earnings conference calls where bank CEOs spoke of their companies' sterling condition and their optimism for the future. They almost uniformly spoke of the growing optimism of their customers — especially those who run small businesses — and of their customers' growing willingness to borrow for investment into new plants and equipment.
Yes, there have been headwinds that crept into the positive outlook — the need to raise deposit rates more rapidly (and higher, in some instances) than initially anticipated, and the mysteriously high frequency of loan pay-downs and payoffs that have dampened aggregate loan demand.
OK, so maybe 2018 was not the very best year ever from the standpoint of banking fundamentals, but in the grand scheme of the past decade it was certainly a year of respectable (or better) profitability. And more importantly, it was not a year of visible excesses — no excessive lending to subprime housing borrowers, a cautious stance on commercial real estate (especially in hot markets), and just generally a lack of crazy stuff on the part of even the largest banks. It seems to me that there has been an air of — well, sobriety — on the part of the banking industry as we approach the end of what has been a remarkably long business cycle, and perhaps prepare for what should logically be a short and relatively mild recession.
But bank stocks are clearly saying something else, and I'm as stumped as anyone about the deeper meaning of bank stock valuations that are hitting rock bottom on a daily basis. At year-end 2018, the KBW Nasdaq Bank Index was down 19.6%, versus a decline of 6.2% for the S&P 500 during the same period.
That overall index comparison does not begin to convey the extent of the damage in individual stocks, especially among those former high-fliers here in the Southeast — like Pinnacle Financial Partners Inc., South State Corp. and Synovus Financial Corp. (to name only a few) — which were all down more than 30% for the year.
What gives? Well, it does not take a genius to see how the market might be spooked about the prospects for the financial stocks as the irresistible force of Federal Reserve Chairman Jerome Powell's march to the neutral rate (whatever that might be) hits the immovable object of Donald Trump's plan (well, sort of a plan) to upend the global trading and economic order and to bend China to his will. Throw in North Korea, Brexit, Democratic control of the House, Trump's seemingly endless legal and ethical issues, the revolving door of the West Wing, and just a general feeling that the inmates have overrun the asylum and — well, off to the crazy races.
Yes, everybody is running scared. There seems to be near-unanimity that something terrible is happening and things can only get worse in the future. But my past long experience has been that bad things happen when nobody expects them — like the summer of 2007, when volatility in the markets was nonexistent, everybody knew that risk had been transferred off of bank balance sheets and would not return, and that a national downturn in the housing market was just not possible.
It does not feel like that now, and when the 'Sunday Styles' section of The New York Times (not a part of that paper known for an emphasis on intellectual rigor) has as its lead headline "Assume Crash Position" and goes on to say "Are you ready for the financial crisis of 2019?" I am sorely tempted to believe that we are getting near a bottom in sentiment. (The overwhelming contrarian indicator of past cycles was the cover of Newsweek, but I'm not sure that it can afford a cover any more.) Of course, much may be determined by the words and actions of Chairman Powell in the coming days and weeks, but I'm also pretty sure that he does not want to be known as the guy who crashed the economy less than one year into his tenure.
Might there be something more insidious going on than just Wall Street group-think and the fear of an admittedly weird yield curve? Maybe. It strikes me that we have been talking about the dangers of the "shadow banks" for many years now but have seen only a few blips in the growth of these lightly regulated quasi-banks. It is entirely possible that further rises in rates will see the deterioration in credit quality in these companies become more pronounced, and it would also seem likely that there would be some degree of spillover into the general economy and into the banking system.
But the most interesting commentary that I have read of late came from a reliable source — Jim Chanos of Kynikos Associates, who has proved his mettle in the past with his short positions in China. He spoke in a Dec. 13 interview with CNBC of his concerns around the "fragility in the system" in that markets are having such a hard time absorbing even small increases in borrowing costs at a time of full employment and growing wages.
He went on to say: "In interest rate-sensitive industries, we're talking about what a slowdown they've seen in the last two months for their business ... Something seems to be a little bit off [if] eight or nine years into a recovery, we can't handle a 10-year — which normally trades about a full point below nominal GDP — that would be 5% right now … If rates went to 5%, I think people would probably lose their minds."
He could be on to something, but what that something is may be hard to discern. It seems to me that the warnings that we have heard for the past few years regarding the increasing concentration of investments into passive vehicles — and the likelihood that these passive investors would all head for a narrow door at some point — may indeed be coming to pass, and that the mechanics of markets that are concentrated and increasingly illiquid are indeed showing their troubling aspects. The banks have steadfastly maintained that the Volcker rule would at some point cause trading liquidity to dry up, and while that rule is in the process of amendment, it may be too late to help much with this latest market "correction."
Yes, 2018 was a terrible, horrible, no good, very bad year — for a lot of reasons. On a personal note, I have had to go through that rite of passage that no only child wishes to contemplate — the loss of my last surviving parent, my mother, on the night of Thanksgiving. As much as I thought I was ready for it, I was not, and her death will resonate through the coming years. But I was both lucky to have had her so long and lucky to have had parents — both coming from cash-poor families — who were always prepared for the future, and lucky that they cared enough to pass that legacy on to me.
So whatever may be coming in 2019 — I'm ready for it. Bring it on.