why are higher interest rates good for banks?

There are two factors involved:

behavior of bank managements:  To a considerable degree, commercial banks are able to use changes in interest rates to their money-making advantage.  When rates are declining, banks immediately lower the interest they pay for deposits but they keep the rates they charge to borrowers high for as long as they can.

When rates are rising, as is the case in the current economic environment, banks do the opposite.  To the degree they can, and given that most loans are variable-rate that is considerable, they raise rates to borrowers immediately.  But they keep the interest rate they pay for deposits low for as long as they can.

A generation ago, banks had a much greater ability  than they do now to maneuver the interest rate spread.  That’s because money market funds were in their infancy.  There were no junk bonds to serve as substitutes for commercial loans.  There was even a Federal Reserve rule, Regulation Q, that prevented banks from paying interest on checking accounts and put a (low) cap on what they could pay to holders of savings accounts.

Nevertheless, especially as rates are rising, spreads still can widen a lot.

economic circumstances:   bank lending business tends to tail off in recession, since most companies don’t want to take the risk of increasing their debt burden during bad times–even if the potential rewards seem enticing.  The credit quality of existing loans also worsens as demand for capital and consumer goods flags.

The opposite happens during recovery.  The quality of the loan book improves and customers begin to take on new loans.

stock market effects

The market tends to begin to favor banks as soon as it senses that interest rates are about to rise.  Wall Street was helped along this time around when perma-bear bank analyst Mike Mayo turned positive on the group for the first time in ages last summer.

After the anticipatory move, banks have a second leg up when the extent of their actual earnings gains becomes clear.  It seems to me the first move has already come to an end   …but the second is still ahead of us.

the wobbly crude oil price

Over the past week or so, the world crude oil price has dropped by about 10%–although it is rebounding a bit as I’m writing on Wednesday morning.

I have several thoughts:

–this is the weakest part of the year for crude oil demand, since the winter heating season is over and the spring driving season is yet to begin

–the surprising aspect of recent crude oil prices is not that they are weak, but rather how strong they have been in January and February in the face of a rising rig count in the US and a milder than average winter in heavily populated areas around the world

–hard as this may be to believe, the price drop suggests to me that many traders in the crude oil market are new to the game, and for some reason haven’t filled themselves in beforehand on the basic characteristics of the commodity

–since there’s a direct relationship between the price of oil and the price of oil exploration and development stocks, the current odd price action in the crude market makes evaluating and trading in the equities more difficult

–I’ve built a small position in e&p stocks over the past couple of months, so I’m sitting on my hands.  If I owned nothing, I’d be tempted to buy something–although I’d be more comfortable if crude had been gradually declining in price over the past month, rather than exhibiting the panicky behavior of the past week.  This is also predicated on the idea that what’s driving crude is thoughts #2 & #3.

the French election?

French elections

As I mentioned yesterday, there’s at least some chance that control of the French government will fall in the Spring to a party that vows to:

–leave the euro,

–engineer a depreciation of the newly-resurrected French franc and

–repudiate euro-denominated French national debt.

This is not just like Brexit, since Brexit didn’t involve government refusal to repay previously incurred financial obligations.  It’s way worse.  This is more like Argentina or Cuba.

Sounds crazy, but so did Brexit and so did Trump.

What to do?

…particularly since it’s hard for me to figure the chances of any of this happening, and I no longer know that much about French stocks.

Two lines of thought:

–avoiding being hurt, and

–trying to make money.

Both will be brief, since I don’t know enough to say any more.

avoiding being hurt

Currency depreciation would have effects much like what’s happened in Japan during the Abe administration.  National wealth and the standard of living of ordinary citizens could take a substantial beating.  Export-oriented industries would thrive.

It’s likely that French companies would have a more difficult time raising money in global capital markets, if France refuses to honor its existing euro-denominated debt.  Companys’ repayment of debt not denominated in francs would become more costly.

Knock-on effects:  my guess is that Italy wouldn’t be far behind France in leaving the euro.  The currency union would likely end up being Germany plus bells and whistles.

The way bond investors are now taking defensive measures is by selling their French government-issued euro bonds for German issues, giving up 0.4% in annual yield to avoid a potential currency loss.

We, as equity investors, can do something similar now, by avoiding non-French multinationals with large exposure to the French economy.  If we want to/need to have some French exposure, it should be in companies that will benefit from possible devaluation–that is, firms with costs in France but revenues elsewhere.  Here the performance of Japanese stocks should be a good guide, except that I’d avoid French companies with a lot of foreign debt.

trying to make money

I consider betting on future political developments to be a dubious enterprise.  If Marine Le Pen makes an unusually good showing in the first round (of two) in French voting in April, and if the French market sells off sharply on that result, I’d be tempted to look for beaten down French multinationals, on the thought that Le Pen would lose in the second round.  I’m not sure I’d actually do anything, but I’d be willing to think about it.  This would imply beginning to study potential purchase candidates, or a suitable ETF, now.




Tesla (TSLA) at $260: what it means

Yesterday, TSLA shares touched $260 early in the day.  That’s the latest high for a stock that has gained 30% since mid-December, a period during which the S&P advanced by 1.8%.

What does this mean?

–On a personal note, it means I don’t own any more TSLA.  Regular readers might reall that one of my sons and I have been trading TSLA between $180-$200 and $250-$260 for the past couple of years.  I had sold some at $250 this time around and placed a limit order for the remainder at $260 about a week ago.  Yesterday, the stock touched $260.00 for a brief period before falling back to close at $257.48.  (An aside:  I find it strange that the stock peaked at such a round number.  I presume this means there’s a lot of stock on traders’ books waiting to be sold in mechanical fashion–meaning with no attempt to entice buyers higher–at $260.)

–The main message, though, is that there’s a lot more going on in the US stock market than the post-election Trump rally–which seems to me to have already exhausted itself anyway.

I’m driving a Kia Sorrento these days, after my Hyundai Veracruz gave up the ghost late last year.  I can imagine my next car being a Tesla.  Nevertheless, TSLA is to my mind the ultimate concept stock.   Yes, the merger with SolarCity is behind it and the death of a driver using the Tesla self-driving feature seems to have been operator error rather than a flaw in the car.  Those are plusses.  On the other hand, the company is still struggling with cash flow breakeven.  And the Wall Street consensus, for what that’s worth, is that it will lose $1 a share in 2017.  So finances continue to be a serious risk.  To my mind, the rally is all about the hoped-for success of the Gigafactory, Musk’s reimagining the car manufacturing process, and the triumph of software over hardware and batteries over fossil fuel.  TSLA’s gains are a testimony to the rude health of the stock market, with or without a Trump tailwind.

–Areas of interest other than aspirational tech or hoped-for tax reform and infrastructure spending?   What about Millennials worldwide?  economic strength in the EU?  regular old tech?  Mexico??  (I haven’t held Mexican stocks for over twenty years, although I’ve had exposure from time to time to that economy through multinationals.  I think it’s too early to make a major commitment, but not too soon to be fact-finding.)




the S&P after the Trump election raly

Taking numbers from Factset, a very reliable source, the S&P 500 is trading at about 17x estimated 2017 earnings.  That’s based on the assumption of slightly more than 10% eps growth from the S&P components this year–a figure I think is reasonable.

This is a potential problem for stock market returns in 2017, since that PE is maybe 12% higher than average for the S&P 500 index over the recent past.  And, of course, interest rates will likely be rising throughout this year and beyond.

Arguably, the elevated PE means that the sharp rally in stock markets since the Trump election has already factored into today’s prices everything positive that Mr Trump is likely to get done during the next 12 months.

That’s the safest assumption.  Concluding that doesn’t imply that there’s no money to be made in stocks in 2107, however.  Instead, it suggests that sector and stock selection will be the only money-making game in town.

Also–and this may simply be my inherently bullish nature taking over–that assumption may be too conservative.  It seems to me an important characteristic of fundamental changes in market direction is that they’re not driven by changes in consensus earnings.  Rather, the market tends to move considerably in advance of changing earnings.

We see this most often as the business cycle waxes and wanes.  At the bottom (top) of the cycle, when the Fed signals that it is going to lower (raise) interest rates, there’s an immediate, significant change in market direction and tone–even though it will take many months for the new interest rate regime to play out in earnings.  We can also observe this in commodity price-driven industries like oil, where stocks react sharply to changes in spot prices.  Oilfield services firms are especially instructive in this regard, since their stock prices tend to react in a high-beta way to oil price changes even though the firms may have long-term, fixed-price service contracts.  That’s because experienced investors realize that when an oil major simply returns a drilling rig to a service company and says it will no longer pay, there’s little that can be done   …if the services firm expects to have any business during the next upturn.


It seems to me that the S&P is now anticipating a similar kind of (favorable) economic step change during the early years of a Trump administration.   I see no reason to bet against this outcome.  This has little to do with Mr. Trump’s obvious flaws; it’s mostly because the electorate has put power decisively into the hands of one party.  If I’m correct, I’d expect the market to move sideways until we get evidence in legislation that substantial fiscal stimulus is under way.  Assuming this occurs, the second half of 2017 will likely be substantially better than the consensus now expects.

Of course, one has to keep the potential for downside clearly in mind.  My biggest worry:  my reading of his business career is that Mr. Trump has saved himself from his substantial bet-the-farm misjudgments (think:  Atlantic City casinos) mostly by throwing his partners under the bus.  In the present case, that’s you and me.



January and the Trump rally

The first couple of weeks in January are usually bad ones for stocks.  Taxable investors typically start their annual portfolio revamping by selling their losers near yearend but they tend to nurse their winners into the following tax year.  From the first trading day in January on, they aggressively prune or jettison profitable positions they no longer think will outperform.

As a result, stocks usually go down in early January.

(An aside:  December losers, especially small caps selling for below $5 a share, tend to bounce back sharply from late-year lows in January.  This is called the “January effect.”  I don’t think it will play an important role this year.)

Not so, so far in 2017.  Instead, the upward movement in the S&P 500 triggered by the surprise election of Donald Trump as president has continued.

Two key differences between today and the last two months of 2016:

–the US$ has, at least for the moment, stopped rising, and

–the market seems to be rotating away from putative Trump administration beneficiaries into left-behind sectors like IT and REITs.

What does this mean?

I think it says that the initial rally on the anticipation of possible pluses from an end to dysfunction in Washington–corporate tax reform, infrastructure spending, and a more normal monetary policy–is getting long in the tooth.  Yes, economic growth appears to be accelerating and consumer confidence is rising.  But potential winners from a Trump administration have advanced by, let’s say, 20% since the election, while more defensive issues have fallen.

Investors are shifting from being driven by concept to being motivated by valuation.  They think, correctly in my view, that the leaders are looking a bit pricey and laggards are looking like relative bargains.  So they’re moving from the first group to the second.

What happens next?

Absent new information, or new inflows of money to equity managers, the market is likely to stall and then sag a little.   The most important factor here is the consensus expectation that the S&P 500 is likely to rise by about 5% for the year as a whole–which would imply there’s severely limited upside, at least until we get further concrete information about the economy or about Congress.

My guess is that the next major move is up.  If so, it will be triggered either by surprisingly good economic data or by bold action to stimulate the economy from Congress.  We should be watching carefully for either.

In the meantime, we can deepen our analysis of Trump beneficiaries, especially, I think, in the Energy sector.  My sense is, day traders aside, there’s no reason to sell (of course, I’m bullish by disposition, so this is my default position).





market rotation: two types

market/sector rotation

Market rotation, sometimes also called sector rotation, is a shift in the pattern of sector outperformance in the stock market.  In 2016, for example, the S&P 500 favored defensive sectors over aggressive ones.  2016 produced the opposite result.


The market rotates for two basic reasons:

change in economic circumstances.  In early 2016, for example, Wall Street began to believe that the price of crude oil, which had been in free fall for two years, finally hit bottom at around $26 a barrel.  So oil stocks began doing better.  Similarly, investors now believe that the election of Donald Trump as president, meaning both houses of Congress and the White House are all Republican, signals the end of Washington dysfunction.  This implies a significant turn for the better in the US economy.  As a result, the most economically sensitive areas of the stock market have been doing better since Election Day.

valuation.  Professional investors often say that “trees don’t grow to the sky,” meaning that at some point sectors that are enjoying an economic tailwind become too expensive relative to those being buffeted by temporary headwinds.  At such times, they will begin to buy stocks in left-behind sectors almost entirely on the idea that as financial instruments they are relative bargains.

short/shallow vs. long/deep

Sector rotations based on valuation tend to be much shorter and shallower than those based on a change in economic circumstances.

the 2015 -16 example

In 2015,  the Healthcare sector rose by +5.2% and Energy fell by -23.6%.  The difference in performance between the two was a whopping 28.8 percentage points.

In 2016, Healthcare fell by 4.4% and Energy rose by +23.7%.  The performance difference between the two was 28.1 points.

what about today?

To me, the extent of the outperformance of the most economically sensitive sectors since the election has been so strong as to invite a market rotation away from them.  My guess is that this will be based mostly on relative valuation.  If so, the turn away from current market leaders will be relatively brief and the correction in these sectors relatively shallow.

For day traders, this will be a big deal; for you and me, not so much.  Our main concern will be the buying opportunity in cyclicals a correction in them will present.