The Full Story:
Early this week, the FDIC seized the feeble First Republic Bank and arranged its matrimony to the stalwart JP Morgan. With regulatory assistance and assurances, JP Morgan paid roughly 10 billion dollars to acquire $100 billion in customer deposits, $200 billion in loans and securities, and $300 billion in wealth management assets under management. While that amounts to a sweetheart deal for Jamie Dimon and JP Morgan, it also established a not-so-sweet valuation mark for embattled regional banks.
On Wednesday, Chairman Powell focused his testimony and remarks on hiking rates and pausing guidance, apparently unconcerned about shotgun weddings and cascading bank failures. JPMs vulture valuation signal, combined with Powell’s systematic inattentiveness and PacWest’s pursuit of “strategic options,” throttled regional bank stocks Thursday with several declining 20% or more. Whether or not these banks deserved their beating isn’t relevant. Banks cannot exist without confidence in them, no matter how robust the fundamentals are. This makes them particularly vulnerable to Twitter tornadoes and short-seller raids.
I listened to several self-serving prognosticators piling on at the Milken conference, calling for the elimination of hundreds of banks. Unfortunately, historical analogs do offer precedent, as significant US bank casualties followed Volker’s inflation-fighting campaign in the early 1980s.
In fact, between 1980 and 1995, 1600 US banks failed. Regulatory rollbacks, financial innovations, and increased competition contributed more to the failure volumes than inflation-fighting rate hikes. Still, the mere suggestion of reprisal supports selling the regionals today “for safety.” Taken together, regional banks plagued by deposit flight, known losses on securities portfolios, unknown losses on loan portfolios, rising FDIC insurance premiums, reactive regulatory overreach, JPM+FRB’s shotgun wedding valuations, heightened recession risks and post-Volker bank terminations history leave little for bank investors to love.
The 144 banks within the S&P Regional Bank index (ticker: KRE) have collectively lost investors nearly 40% in 2023. For those considering bargain shopping, be warned, these names have become trading vehicles with indeterminate value, and the short sellers hold the megaphones. While placing short-term wagers may seem seductive, it has not proven profitable for many in 2023.
Keep your Hands and Feet “Inside” the Vehicle
Sideways markets often tempt longer-term investors to become shorter-term traders. For instance, the dramatic downside volatility in regional bank stocks will undoubtedly produce dramatic upside volatility as well.
Get rich quick!
Similarly, AI-themed stocks ran up dramatically to begin the year, only to sell off sharply over the past month.
Get poor quick!
Timing mistakes trying to catch these booms and busts can dramatically undermine longer-term performance. To judge the environment for better outperformance odds, we often examine the relative performance of the pure style indices vs. the core indices like the S&P 500 index. The pure style indices contain the growth-iest of the growth names and the value-iest of the value names. We call environments when the S&P 500 index outperforms the pure style indices “inside” markets. Conversely, we call environments when the S&P 500 underperforms the pure style indices “outside” markets. “Inside” markets make the S&P tough to beat, and “outside” markets offer multiple ways to win. Here is an account of the S&P 500 and pure style indices performance so far in 2023:
Clearly, per our criteria, this is an “inside” market. Rarely do we see the S&P 500 outperform the pure style indices to this degree. For investors who have ventured “outside,” it’s been an exceedingly difficult year. For W&A, this has led our investment committee to resist chasing immature trends. Until the dynamics of the table above invert, this market remains an “inside” market, full of many ways to lose and few ways to win. The time to chase volatility and trends will come, but it’s not now. Keep your portfolios unimaginative for now. Often in investing, boring is better.
Caveat: This analysis was domestic. Internationally, the trends have proven much more reliable. The EAFE index (largely Europe) has appreciated 11% year to date and has outperformed the S&P 500 over the one-month, three-month, year-to-date, and one-year timeframes. In fact, while the S&P 500 has fallen 4% over the past year, the EAFE has appreciated 6.5%. Even if we incorporate every single international stock, including the challenged Chinese names, the outperformance remains with the MSCI Total International Stock Index (Ticker: IXUS) up 8% against 6% for the S&P 500. Given our global approach, our offshore investments have provided a welcome ballast for our onshore investors.
Have a great weekend!
David S. Waddell
CEO, Chief Investment Strategist