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Vol. VI, No. 2

TOM BROWN’S BANKING WEEKLY: 1/15/21

Financial Services Insights and Intelligence

FIRST WORD: Bank OZK’s CEO George Gleason. There have been some great founder-CEOs in the banking business over the years, but I would put Bank OZK’s George Gleason’s 41-year record up against any of them. For years, he has been one of my favorite CEOs to talk with because he is so thoughtful, confident, and direct. He never tries to tell an analyst or investor what he thinks the person wants to hear, because he doesn’t really care; he’s not out to get a “buy” recommendation or even a new shareholder if the analyst or investor doesn’t have an accurate picture of the company’s strategy and tactics. Gleason’s unconventional approach of truly running a public company with a long-term approach has created tremendous value. Gleason is Bank OZK’s fifth-largest shareholder, owning 5% of this company with a $4.7 billion market capitalization. Since 2000, the KBW Bank Index is up 50% while Bank OZK is up 3,100%! Given the company’s concentration in commercial real estate lending, its stock price can be volatile, as investor concern about the company’s exposure to CRE lending ebbs and flows—despite the company’s consistently strong credit performance. (Bank OZK is arguably the best commercial real estate lender in the country.) Since the bank stock rally began on November 9 of last year, both Bank OZK and the KBW Bank Index are up around 35%. If the economy takes off this year, as is widely expected, so will Bank OZK’s stock valuation, I suspect. Bank Director published a very worthwhile interview with Gleason at the beginning of the year, in which he discusses the company’s culture and his view that this year will present some acquisition opportunities.

DELIRIOUS: What’s a wall of worry, again? According to Citi’s Panic/Euphoria model—which, if I’m reading this chart correctly, really does seem to correlate with forward market returns—investors haven’t been this giddy since, well, ever.

Not good.

ONE-WAY MARKET: While I’m on the topic of investors having more or less lost their minds, Schwab’s Liz Ann Sonders notes that Goldman Sachs’s most-shorted-stock index has more than tripled since last March.

THE RECESSIONARY DAMAGE WILL BE FAR LESS FROM THE RECESSION OF 2020 THAN FROM THE LAST RECESSION: This is a puzzle. I’m at a loss to understand why bank stocks have lagged so much more during this recession, even as bank balance sheets have stayed strong while credit losses have been minimal, compared to how the stocks did during the last recession, which was essentially a near-death experience for the entire industry. But that’s what’s happened. Sometimes Mr. Market really does go off the deep end.

GOING ONLINE: I did a podcast this week with BAI where I talk about what I expect for the banking industry, and the economy in general, in 2021. To listen to it, click here. Also, a reminder: to sign up for the “Route 2021” BAI webinar I’ll be doing on January 26, click here.

JPMORGAN’S IMRESSIVE RESULTS: JPMorgan Chase, was just one of the first companies to report fourth-quarter and full-year earnings results today, and it’s worth taking a step back to admire the strength of the franchise. Despite having to deal with all the unexpected issues related to a global pandemic, JPMorgan reported a 4% increase in revenues, to $123 billion, built its loan loss reserve by $12.2 billion (net chargeoffs were just $5.3 billion) compared to no reserve build in 2019, yet its net income was down just 21% and it still earned a 14% return on its tangible common equity. Given the environment, that’s quite impressive.

MIXED SIGNALS: Say, the consistency of the Fed’s messaging sure is reassuring, isn’t it? The Wall Street Journal, Tuesday:

CNBC.com, same day:

Helpful!

GO AWAY AND STAY AWAY: Ugh. Some employers are trying to get rid of private offices again. Actually, it’s worse than that. They won’t let employees return to their offices even if they want to. From the Wall Street Journal, on Wednesday.

As the coronavirus upends work, a number of employers say corporate spaces should exist largely, or in some cases entirely, for team-based projects. Companies  . . . are now drawing up plans to rip out individual desks and renovate offices to include floors of meeting rooms and lounges, with workers directed to do their own work at home. . . .

“We’ve gone through a one-way door,” says Drew Houston, founder and chief executive of the technology company Dropbox, which has spent months rethinking its offices and workplace practices. “This is a permanent shift.”

Dropbox is among a small but growing cadre of employers embracing the deskless post-pandemic trend. The company told staffers last year that, once its facilities reopen, it will declare offices near San Francisco and elsewhere essentially off limits to individual work, transforming them into what it calls “Dropbox Studios” for meetings and collaboration among teams. [Emphasis added.]

 “Dropbox Studios.” Snappy! I predict that this new working arrangement, which is of course a sharp break with the way companies have managed their workforces for, well, as long as anyone can remember, will end in ignominious disaster. It’ll be interesting to see, first of all, how successful Dropbox’s recruiting efforts will be once the company tells prospective hires they won’t be allowed in the office except under certain circumstances. What’s more, that “This is a permanent shift” crack from the Dropbox CEO, in the face of zero evidence that the planned new arrangement will be successful, ominously smacks of this-time-it’s-different-ism, no?

THE WEIGHTING OF FINANCIAL STOCKS IN THE S&P 500: Reversion-to-the-mean alert! The financials’ weighting in the S&P 500 has now fallen by so much that it’s as low as it’s been (except during the financial crisis) in nearly 30 years.

RESURGENT: Say, maybe the economy isn’t rolling over quite as much as some observers are saying. Recent purchasing managers surveys are pointing to an acceleration of revenue growth for the S&P 500.

A NEW DAY: What a difference a few months, a couple of vaccine approvals, and a 60-basis-point increase in long term interest rates has done to the valuation of bank stocks.

MISMATCH: Here we go again. Citigroup will merge its retail and institutional wealth management groups with an eye towards converting more of the executives of its institutional clients into wealth management clients, as well.  From the Wall Street Journal, on Thursday:

Bank executives have talked about using Citigroup’s commercial bank and global relationships with companies to funnel executives into wealth-management products. They are especially interested in attracting more customers in Asia—where the bank has a consumer and credit-card business. [Emphasis added.]

Oof. Banks have been trying to do this—generating “client synergy,” it used to be called—for as long as I can remember, and it never works. I’ll spare you the nuances of the retail-vs-institutional politics at most broker/dealers, but, trust me, not many bankers who have spent years developing strong, highly lucrative relationships with institutional clients are going to put those relationships at potential risk by allowing the client’s executives’ investment money to be handed over to some stockbroker down the hall who might screw things up. Anyway, mark me down as skeptical.

LOOMING: You don’t say:

Finally! The problem is that she—along with just about all of her Fed colleagues, from what I can tell—seems to think that accelerating inflation would be a good thing, not a bad thing.

LET THE CONFERENCE CALLS BEGIN: Happy earnings season! For what it’s worth, the dozen or so companies that have already reported their earnings topped consensus estimates by an average of 14%, Bloomberg reports, compared to an average beat over the past two quarters of 21%. Overall, the consensus expects that the S&P 500’s earnings dropped by 8.5% last quarter, and looks for gains of 23% this year and then 17% in 2022.

DIVERGING: An ominous unintended consequence of the Fed’s latest round of QE-ing? Who could have expected? From Jeff Gundlach’s conference call on Tuesday: as long-term interest rates have been held down at artificially low levels, commodity prices have—surprise!—begun to soar.

While I’m on the topic of the unhappy side effects of interest rates being rigged across the curve, here’s another notable chart from Gundlach this week. I read it to mean that nobody can say for sure whether the stock market is currently cheap or expensive (even you, Jeremy Grantham) since nobody knows for sure what the true, market-cleared interest rate is that the stock market’s earnings yield should be judged against.

“Equity is expensive . .  and not expensive” is a heck of a heading to put on a chart, but I understand exactly what Gundlach is talking about.

JUST THE BIG BANKS: Oh brother. Sen. Sherrod Brown of Ohio takes over as Chairman of the Senate Banking Committee when the Senate reconvenes later this month. Brown has a 14-year track record of disdain for the largest U.S. banks and an insurmountable belief that he has all the right answers. Testifying before the committee will be even more “fun” now than it used to be.

OUTWARD BOUND—1: Golly. People really can’t leave New York City fast enough.

OUTWARD BOUND—2: Speaking of people stampeding out of cities, in San Francisco, the amount of office space available for rent is triple what it was a year ago, as space offered for sublet, in particular,  has soared.

UP EARLY: Don’t ask me why this should be, but it apparently is: in any given month going back to 1896, roughly half the gains in the Dow Jones Industrials happened during that month’s first six days, reports blogger and money manager Eddie Elfenbein.

BIG MO: I kind of buy this in a weird way, to tell you the truth. Yardeni Research’s Ed Yardeni says that the stock market’s recent strength could be a sign that . . . stock prices are about to surge even more. Here he is on CNBC, last Friday.

The Nasdaq from late 1998 to early 2000 went up over 200%. Now, we’re up almost 100%, and we may very well be on that same track. Everything I’m looking at points to a melt-up. [Emphasis added.]

Amen to that! I enjoy a stock market melt-up as much as anyone. It’s what often happens once they’re over that can be kind of unpleasant.

NOT A BUYER: Not so long ago, who would’ve imagined that this could ever happen? Imports of oil from Saudi Arabia into the U.S. have fallen to . . . zero.

 HAS THE WORM TURNED?: The Russell Value Stock Index underperformed the Russell 2000 Growth Stock Index by 30 percentage points last year, the worst year for value vs. growth since 1999.

But last year’s dismal performance by value could be a hopeful omen. In the year following the large underperformance in both 1999 and 1980, value stocks came back the next year to trounce growth stocks.

AT AN EXTREME: I have to admit, a chart like this tends to put a damper on my generally all-season bullishness:

This one, too:

BOLD FORECAST: A ten-year Treasury rate over 2% and a steepening of the yield curve by 90 basis points by the end of this year is the new forecast from Evercore ISI’s Stan Shipley. He thinks economic growth will improve, more vaccine treatments will occur, and inflation will begin to increase.  Put me in Shipley’s camp on all three points.

RETAIL TRADING ACTIVITY: For a number of reasons (free stock trading, stimulus checks, and a volatile equity market, among others) the last twelve months has seen a surge in retail interest in the stock market, as evidenced by the huge increase in visits to the websites of online brokers and the fact that retail trading accounted for 45% of the total equity trading at the end of last year, which was much higher than it has been historically.

AGGRESSIVE BIDDERS: And what have all these busy retail investors been up to lately? Well, here’s a clue: the number of stocks trading at ten times sales or higher—ten times sales!—has lately been surging:

NEXT WEEK: On Wednesday, the National Association of Homebuilders will release its Builder Optimism Index for January. The consensus expectation is 85 vs 86 in December. Then on Friday, we’ll get the Markit Purchasing Managers Indices for manufacturing and services, both for January. For manufacturing, the consensus looks for 56.5 vs 57.1 in December. For services, the consensus looks for 53.6 vs 54.8.

THE LAST WORD: Before Christmas, I told Amy that I wanted to give each of our children a portfolio of six Schwab stock slices. I explained that Schwab now makes it possible to own a portion of a share of stock for as little as $5. I wanted our children to appreciate how a portfolio works, with some investments going up while some go down because of the many factors that influence stock prices on a short-term basis. I planned to give them $200 invested in six companies, so they each would receive $1,200 in value. At first Amy and I thought about tailoring the portfolios to match the interests of each child individually, but we decided against that because I don’t know much about such companies and I am very excited about the prospects for financial stocks this year. I picked six which included two consumer finance companies (Ally and Curo Group), three banks which are focused on attractive niches (Bancorp Bank, MVB Financial, and Triumph Bancorp), and one large banking organization (Capital One). The children have to own these stocks until July 1, at which point they can do whatever they want (trading is free) or use the money for something else.

Our plan ran into the first hurdle when Schwab wouldn’t let us open accounts for the children because none of them are minors. This actually made it better in my eyes, because they would not receive the $1,200 until they actually opened an account. They liked the idea and were ready to get going. The most ambitious reported back that Schwab only provided slices for stocks in the S&P 500, and only Capital One was in the index. So I suggested he try Robinhood and Fidelity. He found Robinhood so easy to operate, and if he referred a friend they each would receive a slice of an unnamed company from Robinhood. Word quickly spread among the kids, such that by the end of day 2 they all had a Robinhood account, I had Zelled them all the money, and they owned a portfolio of slices.

Now they are learning what it is like to be an equity owner: you check prices all the time when you are making money and feeling like a rich genius, and when one or more of the slices declines in price, they give me the cold shoulder. As of this morning, all six are up ranging from 6% to 23%, with an average of 15%. The inevitable correction will come, at which point they will learn another lesson of investing, that it’s not black and white. Earnings performance and valuation will determine shareholder return. For instance, Coca Cola’s earnings went from $3.5 billion in 1998 to $11.8 billion in 2010, an increase of 337%, yet its stock price rose just 1% in total over this period. So far, it’s been a great and fun learning experience for all of us, and Amy and I are looking forward to what the children do after July 1.

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Edited by Matt Stichnoth.

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