This is crazy
June 4, 2019

Blain's Morning Porridge 

This is crazy. Some analysts are predicting three US Federal Reserve eases by year end. Australia and New Zealand have cut rates. German yields are now negative 0.21 percent. Nothing screams recession more loudly! The market is discounting US rates 70 basis points lower. Everyone is listening for what the Fed says next, and it's a Fed-heavy schedule of speakers this week. Fed Head Jerome Powell could firm the tone when he speaks later today, but we've already had a dove, Lael Bullard, warning "downward policy may be warranted".

What's really happening? A pre-emptive Fed getting ready to mitigate the negative effects of Trump's trade Twitter war on the economy? Or do the real data really suggest the last thing the US needs is further monetary distortion from overly low rates, and what's really happening is the Fed is pandering to a wobbly stock market? Massive deflationary risk lies somewhere down the timeline.

The stock analysts are loving it. They see lower rates driving renewed upside – they don't care about the long-term distortions! All they want is a schweet short-term hit of rate easing to put stocks back into the stratosphere.

When bonds are yielding very little (I was going to say the square root of nothing, but one investment banking pedant sent me pages of maths yesterday explaining why that isn't a good metaphor), then it stimulates dangerous yield tourism. Low rates encourage bad things – like corporates to overleverage themselves to mount stock buybacks with debt – which increases executive bonuses but doesn't build new factories or infrastructure. The end result is a more distorted market reliant on lower forever rates to stop the bubble bursting. 

Short term, it's great. Fill your boots with stocks. Long term…Be very aware it is not real. 

Perhaps the bubble is stretching to bursting point in the tech sector. Yesterday's news about anti-trust investigations into names like Facebook, Alphabet, Amazon and others might have been a lightbulb moment – but it's been enough to remind investors of regulatory risk as the US agencies divvy up names to attack! 

Instead of dwelling on the distortions of the Anglo-Saxon markets, let's take a look at Europe. If you really want a disappointing stock to follow, then try Germany's "leading" bank. It's so bad, I thought I'd find fund manager of the moment Neil Woodford listed among the largest holders of the stock! 

As Deutsche Bank tumbles to new lows - dragging other lame European banks in its plummeting wake - you have to wonder where it ends. It's getting embarrassing – you almost wish they'd do the honourable thing. But no, the CEO, Christian Sewing, is coming back with yet another plan to cut headcount in rates and equity trading to restore profitability by the end of July.

The cost of CDS (credit default swap) protection has rocketed, but I'm actually surprised the bank's CoCos (contingent convertible bonds) aren't lower given Deutsche's previous history of pleasing investors when it has missed calls! I'm afraid DB looks, smells and feels like a complete mess. I'm awarding Bloomberg a special prize for pointing out investors are frustrated at its 90 percent decline since the global financial crisis. NSS!

But it's not just Deutsche. Right across the whole European banking sector the names honk and are spiralling lower in a sea of red. European banks – you'd have to be daft to buy them - yet more than a few stockpickers say…"they will represent value, soon!" Anything – with the possible exception of DB – has value when it is cheap enough. 

When I was young, a long, long time ago in a galaxy far, far away, European banks dominated the league tables for bank lending, IPOs (initial public offerings) and Eurobonds (proper old-fashioned Eurobonds as invented by SG Warburg, not today's bonds denominated in euros).

Today, they are practically absent. Why have the Americans bloomed while Europe has rotted? It's a question of environment and supervision. The US authorities dealt aggressively with banks during the crisis. Lehman demonstrated they were serious. They forced banks to accept recapitalizations and the banks responded by paying back as quickly as they could. And the banks were encouraged to go out and start banking again. 

In Europe, the banking crisis came later, and the banks never so thoroughly cleansed and reinvented themselves. Their underlying weakness was considered a secondary aspect of the European sovereign debt crisis. Free TLTRO (targeted longer-term refinancing operations) money from the European Central Bank kept them afloat, but primarily allowed them to stabilize spiralling European sovereign debt markets.

But…there was no rebuild, and no reinvention of banking. European banks remain essentially national banks, meaning post-crisis austerity kept them from any kind of stable recovery, and unable to really address ongoing bad lending.

We all know the European banks' obvious problems. They are being spanked by low interest rates, falling bond yields and rising trade war threats. But it's a more complex story than that; rising regulatory costs and compliance will soon exceed 10 percent of revenues across Europe's dismal banking scene.

The fact that most European banks trade below asset value hints that we don't believe where the banks value these assets. No surprise. Banks holding assets in basket case countries – yes, I am thinking of Italy – remain vulnerable. Deutsche is the worst – trading at 18 percent of book value. Isn't Germany supposed to be Europe's economic hot spot?

The extended period of ultra-low and negative low interest rates for European banks has done nothing to improve credit quality. Instead, it has enabled zombie borrowers to survive for longer, meaning any recovery is likely to trigger a normalization in default rates. And European banks are still plagued by high non-performing loans. 

It's not just Deutsche. The Wall Street Journal recently pointed out that the eight largest European banks have triple the assets of, but are worth less than, JP Morgan! Italian banks are massively exposed to Italian debt – and there isn't any way that's a positive. Even decent names like BBVA and Santander are being caned – they had the good sense to seek earnings outside Europe, but this week are being pulled down by their Mexican affiliations.

Where do we think European banks are going? They are burdened with an overbanked market, ageing systems, a lack of resources to digitize and reinvent their services, and there are still no signs of any European banks emerging as cross-border champions.

European banking union is another EU initiative that seems to have drowned in the sea of bureaucracy that sinks everything. Governments still see their duty as protecting national banking champions. There is repeated regulatory failure, such as with Danske Bank in terms of money-laundering, and the collapse of Spanish and Italian banks doesn't help. No European banks are expanding, building market share. Instead they are all retrenching.

If I could think of something positive to say about Europe…but I really can't…. 

Out of time and back to the day job…  

Bill Blain

Shard Capital





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Blain's Morning Porridge 

This is crazy. Some analysts are predicting three US Federal Reserve eases by year end. Australia and New Zealand have cut rates. German yields are now negative 0.21 percent. Nothing screams recession more loudly! The market is discounting US rates 70 basis points lower. Everyone is listening for what the Fed says next, and it's a Fed-heavy schedule of speakers this week. Fed Head Jerome Powell could firm the tone when he speaks later today, but we've already had a dove, Lael Bullard, warning "downward policy may be warranted".

What's really happening? A pre-emptive Fed getting ready to mitigate the negative effects of Trump's trade Twitter war on the economy? Or do the real data really suggest the last thing the US needs is further monetary distortion from overly low rates, and what's really happening is the Fed is pandering to a wobbly stock market? Massive deflationary risk lies somewhere down the timeline.

The stock analysts are loving it. They see lower rates driving renewed upside – they don't care about the long-term distortions! All they want is a schweet short-term hit of rate easing to put stocks back into the stratosphere.

When bonds are yielding very little (I was going to say the square root of nothing, but one investment banking pedant sent me pages of maths yesterday explaining why that isn't a good metaphor), then it stimulates dangerous yield tourism. Low rates encourage bad things – like corporates to overleverage themselves to mount stock buybacks with debt – which increases executive bonuses but doesn't build new factories or infrastructure. The end result is a more distorted market reliant on lower forever rates to stop the bubble bursting. 

Short term, it's great. Fill your boots with stocks. Long term…Be very aware it is not real. 

Perhaps the bubble is stretching to bursting point in the tech sector. Yesterday's news about anti-trust investigations into names like Facebook, Alphabet, Amazon and others might have been a lightbulb moment – but it's been enough to remind investors of regulatory risk as the US agencies divvy up names to attack! 

Instead of dwelling on the distortions of the Anglo-Saxon markets, let's take a look at Europe. If you really want a disappointing stock to follow, then try Germany's "leading" bank. It's so bad, I thought I'd find fund manager of the moment Neil Woodford listed among the largest holders of the stock! 

As Deutsche Bank tumbles to new lows - dragging other lame European banks in its plummeting wake - you have to wonder where it ends. It's getting embarrassing – you almost wish they'd do the honourable thing. But no, the CEO, Christian Sewing, is coming back with yet another plan to cut headcount in rates and equity trading to restore profitability by the end of July.

The cost of CDS (credit default swap) protection has rocketed, but I'm actually surprised the bank's CoCos (contingent convertible bonds) aren't lower given Deutsche's previous history of pleasing investors when it has missed calls! I'm afraid DB looks, smells and feels like a complete mess. I'm awarding Bloomberg a special prize for pointing out investors are frustrated at its 90 percent decline since the global financial crisis. NSS!

But it's not just Deutsche. Right across the whole European banking sector the names honk and are spiralling lower in a sea of red. European banks – you'd have to be daft to buy them - yet more than a few stockpickers say…"they will represent value, soon!" Anything – with the possible exception of DB – has value when it is cheap enough. 

When I was young, a long, long time ago in a galaxy far, far away, European banks dominated the league tables for bank lending, IPOs (initial public offerings) and Eurobonds (proper old-fashioned Eurobonds as invented by SG Warburg, not today's bonds denominated in euros).

Today, they are practically absent. Why have the Americans bloomed while Europe has rotted? It's a question of environment and supervision. The US authorities dealt aggressively with banks during the crisis. Lehman demonstrated they were serious. They forced banks to accept recapitalizations and the banks responded by paying back as quickly as they could. And the banks were encouraged to go out and start banking again. 

In Europe, the banking crisis came later, and the banks never so thoroughly cleansed and reinvented themselves. Their underlying weakness was considered a secondary aspect of the European sovereign debt crisis. Free TLTRO (targeted longer-term refinancing operations) money from the European Central Bank kept them afloat, but primarily allowed them to stabilize spiralling European sovereign debt markets.

But…there was no rebuild, and no reinvention of banking. European banks remain essentially national banks, meaning post-crisis austerity kept them from any kind of stable recovery, and unable to really address ongoing bad lending.

We all know the European banks' obvious problems. They are being spanked by low interest rates, falling bond yields and rising trade war threats. But it's a more complex story than that; rising regulatory costs and compliance will soon exceed 10 percent of revenues across Europe's dismal banking scene.

The fact that most European banks trade below asset value hints that we don't believe where the banks value these assets. No surprise. Banks holding assets in basket case countries – yes, I am thinking of Italy – remain vulnerable. Deutsche is the worst – trading at 18 percent of book value. Isn't Germany supposed to be Europe's economic hot spot?

The extended period of ultra-low and negative low interest rates for European banks has done nothing to improve credit quality. Instead, it has enabled zombie borrowers to survive for longer, meaning any recovery is likely to trigger a normalization in default rates. And European banks are still plagued by high non-performing loans. 

It's not just Deutsche. The Wall Street Journal recently pointed out that the eight largest European banks have triple the assets of, but are worth less than, JP Morgan! Italian banks are massively exposed to Italian debt – and there isn't any way that's a positive. Even decent names like BBVA and Santander are being caned – they had the good sense to seek earnings outside Europe, but this week are being pulled down by their Mexican affiliations.

Where do we think European banks are going? They are burdened with an overbanked market, ageing systems, a lack of resources to digitize and reinvent their services, and there are still no signs of any European banks emerging as cross-border champions.

European banking union is another EU initiative that seems to have drowned in the sea of bureaucracy that sinks everything. Governments still see their duty as protecting national banking champions. There is repeated regulatory failure, such as with Danske Bank in terms of money-laundering, and the collapse of Spanish and Italian banks doesn't help. No European banks are expanding, building market share. Instead they are all retrenching.

If I could think of something positive to say about Europe…but I really can't…. 

Out of time and back to the day job…  

Bill Blain

Shard Capital



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