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Unguided

Banking Essentials Newsletter December Edition Part 2

Banking Essentials Newsletter - November Edition

University Essentials | COVID-19 Economic Outlook in Banking: Rates and Long-Term Expectations: Q&A with the Experts

Estimating Credit Losses Under COVID-19 and the Post-Crisis Recovery


Unguided

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.

Well, here we go. It's official now, there is a movement underway — on its way to becoming a tsunami, I'm sure — for American companies to stop giving earnings guidance to Wall Street analysts on a quarterly basis.

JPMorgan Chase & Co. CEO Jamie Dimon had hinted as much earlier this year, and Mr. Dimon and his fellow investment titan Warren Buffett have now come out definitively to lead the anti-guidance campaign. Indeed, Mr. Dimon is using his position as head of the Business Roundtable to spearhead this effort, and a number of CEOs within that premier group have already announced that they will cease giving earnings guidance in the near future.

I am, perhaps predictably, of two minds on this issue. I cannot disagree that the practice of providing earnings guidance by companies over the years has led to a short-term orientation on the part of many American businesses to "make the number," and that important investments in technology and people may have been postponed or entirely rejected as a result. I also cannot deny that the analytical community, or at least some sizeable part of it, depends upon guidance for formulating their earnings models, sometimes in contravention of what they know to be possible, or even prudent, for earnings growth.

And there is undeniably a part of the investment industry, i.e., the faster-triggered hedge funds, that relies upon positive earnings surprises, or their opposite condition, for short-term trading gains to goose returns, although much of that segment thankfully died a natural death in the recent years of low volatility. But as Mr. Dimon and Mr. Buffett have admitted, there are a number of other factors, including executive compensation plans that depend upon the attainment of short-term profitability metrics to achieve big year-end paydays, that play into an earnings ecosystem that has admittedly become skewed to the short term.

My own private bugaboo during my years on the sell-side was the First Call system, which I now believe amplified the reliance on guidance and just contributed overall to a climate where rapidly delivered verbiage was confused with real analysis and investment wisdom. I was always an analyst who took time to write — anyone who has seen me work knows that I am a relentless self-editor as well as a grammar freak — and more than once I found a research director peering over my shoulder asking me why my note was not out yet. The ability to get the note out quickest became the standard by which many Wall Street analysts were judged, and often compensated, and the whole system just became crazy and counterproductive.

I'm hopeful that the changes that have taken place on the sell-side since the financial crisis, with the resultant forced downsizing of sell-side research departments, have influenced the choice of quality over quantity on the part of the consumers of research. I know that the weirdly named and much-feared Mifid — and its successor, Mifid II — have had an impact far beyond the reach of the EU constituency for which it was originally intended. The Markets in Financial Instruments Directive, a mere 1.4 million paragraphs of rules, is designed at its heart to make investing more transparent and to show the asset management industry's clients what they're actually paying for with all those fees.

The result has been a nightmare for Street firms, as large American asset managers who do business in the EU, and that's roughly all of them, have adopted these rules not only for their European research departments but for their American units as well. These rules have forced buy-side analysts here not only to account for all their interactions with the Street but to justify, in great detail, the reasons that they are allocating increasingly scarce commission dollars to one analyst or another.

Predictably, access to company managements has become an even more precious commodity, to the detriment of many smaller firms, but the more positive aspect to me has been that good analysts are also getting rewarded for independent thinking, while the "guidance huggers" are increasingly falling by the wayside.

But I would also say to Mr. Dimon and Mr. Buffett: Be careful what you wish for. There will still be a need to review quarterly earnings, and the absence of guidance will mean that there are going to be a lot more boring questions and that even greater amounts of detail will be called for. As the analyst-averse, and breathtakingly arrogant, Elon Musk recently learned, calling analysts' questions "boring" and then going on to talk about grand concepts is not going to cut it, and an absence of guidance will not equate to greater transparency. And while I do not agree with one industry pundit who said that "rumor and innuendo" would fill the void left when guidance dries up, those CEOs who abandon guidance should be prepared for the consequences if there is bad news to promulgate.

There is one place where I have real misgivings about the issue of lessened guidance, and I think that Mr. Dimon particularly should give this matter some thought. Banks are not like other companies in one important regard — bad news for a bank can often mean bad news for the banking industry and bad news for the economy overall, and an unexpected negative development at a bank as large and prominent as JPMorgan would rip through the banking industry and the American economy pretty quickly. There would be, to put it mildly, a panic, and Chase's stock would not be the only casualty.

I think that the subject of guidance by bank managements is a particularly important one now, as we come into year nine of the American economic expansion — the longest one on the books was 10 years — and as the Fed begins a program of aggressive rate increases and balance sheet shrinkage, impacts to the banking industry are certain to result. One of those impacts will inevitably be a change in a credit quality environment that has remained benign way past any expected point of inflection, and I would posit that bank stock investors are not yet fully ready for this fundamental shift. In my view, it will be incredibly important for measured and calm guidance to come from the senior ranks of the nation's largest banks in order to facilitate an ordered transition back to a more normal credit cycle.

Yeah, I get it — the world would be a better place if we all thought and then acted in the long term. Investors everywhere would adopt a buy-and-hold philosophy, would be willing to suffer the vagaries of business cycles and changes in management strategies, and would have confidence that the American economy is always being guided by rational fiscal and monetary policymakers. I can only recall the final words spoken by Jake Barnes in Hemingway's The Sun Also Rises: "Isn't it pretty to think so?" But in the midst of Trump's America — where national direction can seemingly change with a tweet — "unguided" strikes me as possibly misguided, and as an idea whose time has not yet come.