A few months ago, I wrote about strong insider buying and how it can be a promising sign for a company’s future stock performance. Last week, JPMorgan Chase’s CEO Jamie Dimon paid $26.6M for 500,000 of the company’s shares at $53/share. That’s about as strong as insider buying gets. The news immediately boosted the bank’s stock. It closed yesterday at $58, though it is still down 12 percent YTD versus a 6 percent decline for the S&P 500 and a 16 percent decline for the S&P 500 banking sector (KBE).
To his credit, Dimon has consistently bought large amounts of his company’s stock over the years, and his investments have always turned out well for him. Many analysts believe his latest purchase could signal a bottom for the financial sector. Does that mean investors should follow Dimon into JPM and other bank stocks?
I have my doubts.
Historically, financials–which make up roughly 20 percent of the S&P 500–have sold at lower price-earnings multiples than other sectors. This reflects the high leverage inherent in every bank’s operating model, as well as the fact that bank earnings are a function of interest rates and the “spread” between what they pay for deposits versus what they earn on their loan portfolios. Looking at JP Morgan’s PE, in particular, it has fallen temptingly close to the 9x multiple where it stood at the time of Dimon’s last major purchase in July of 2012, when he bought half a million shares at $34/share:
However, three problems could easily continue to challenge bank profits in the coming years:
One: economic growth. I don’t mean to be a broken record (I’ve been saying this for years) but we are still growing at a disappointing snail’s pace. Last year the US economy expanded by a mere 2.4 percent, continuing the slowest post-recession expansion on record and marking the seventh consecutive year of sub-3 percent growth. Yet, compared to the rest of the world, we’re doing great. Growth in Europe and Japan was even more anemic, and China, whose $10 trillion economy is the world’s second largest (US GDP is $18 trillion), grew by “only” 5.9 percent. Investors worldwide are justifiably concerned this sluggish growth will hamper loan growth and increase the amount of nonperforming loans (and loan write-offs) in 2016 and beyond.
Two: oil, oil, oil. As an old saying goes, when you owe the bank a million bucks, it’s your problem, but when you owe the bank a billion dollars, it’s the bank’s problem. No industry creates profits for banks during good times and nightmares for them during downturns like the energy industry—and the current energy nightmare could be just beginning.
Last year, the Bank for International Settlements put the total debt of the global oil and gas sector at roughly $2.5 trillion. Unless oil prices significantly recover, loan losses will steadily increase over the next 12-18 months and bankruptcies at both public and private energy companies will be plentiful. Many banks have made reassuring pronouncements that they have set aside capital for the inevitable write-downs to come. But financial institutions made similar pronouncements during the last major oil crash in the mid-1980s. I know because I was working at the largest bank in Texas at the time. When oil prices finally recovered, my employer had been bought out (and today, believe it or not, is JP Morgan Texas!). Every other large Texas bank was bought out by the late-1980s, as well, all with government assistance. While the Texas economy is now less dependent on energy, energy lending is still a large part of the loan portfolio at our nation’s largest banks. Those institutions with high energy exposure will have to take sizable write-downs and some smaller banks in energy dependent regions (and energy dependent countries) could fail.
Lastly: politics. I’m not sure the market has fully priced in the political risks facing the financial sector. The Republican Party has lost the popular vote in 5 out of the last 6 elections, and it doesn’t look like that trend is going to change in 2016. Current frontrunner Donald Trump is anathema to two large and fast growing voting blocs in the country—single women and Latinos—and the party’s remaining candidates don’t fare much better among those key constituencies. (Remember, Mitt Romney won the highest percentage of white male voters in American history and still lost by five million votes.) That means our next president, whether it is Bernie Sanders or Hillary Clinton, is likely to be someone who has pledged to strengthen Dodd-Frank, possibly bring back Glass-Steagall, and even break up the largest US banks if necessary. None of those policy positions stand to benefit financial companies or their shareholders.
I applaud Mr. Dimon for his insider buying. But there are just too many things that can go wrong for the financial sector in the coming years for me to share in his optimism.