JPMorgan Chief Jamie Dimon’s 66-page annual letter to shareholders came as an early gift last week ahead of big bank earnings. Don’t worry, I’m not going to give you a spiel the same length as the letter. Relevant short highlights will suffice. The CEO’s report included things like lessons learned from his leadership since 2005, the importance of being a corporate citizen, and the evolving changes to the financial industry. However, for the sake of this article, we’ll be focusing on the economic landscape segment of the report since banks play a significant role in indicating the health of the economy.
Dimon’s outlook on the economy can be best described as not too hot and not too cold, but just right – the Goldilocks of recoveries. He addressed the bold action taken by the Federal Reserve with its different credit facilities to support the bond markets and quantitative easing measures to lower interest rates. In addition to the action taken by the federal government providing fiscal aid directly to businesses and individuals. JPMorgan played a significant role in the PPP program with funding over 280,000 loans for more than $32 billion in 2020. With the number of consumers saving in excess, new stimulus savings, significant government spending, easing monetary policy, and vaccine success, it’s difficult not to picture the probability of an economic boom on the horizon. However, unpredictable events can always curb these outlooks.
While many have been critics of the magnitude of the measures taken, the speed and scope of the programs were critical. It’s easy to criticize action that’s already been taken since hindsight is always 20/20, but Dimon points out that there was no way it could’ve been done perfectly with the demand for immediate action being so great.
Banks had entered the crisis in good shape. Largely due to the regulatory measures taken after 2008 to increase capital and liquidity requirements. Prior to the Great Financial Crisis, banks primarily lent out very close to how much they were receiving in deposits. In the graphic below, you can see loan-to-deposit (LDR) ratios as high as 99% before 2008 but have dropped significantly with the Dodd-Frank Act enforcing new liquidity requirements. A lower LDR is healthier for the banking system since it provides more coverage for potential loan defaults, especially in a recession. The spread between deposits and loans grew further in 2020 with the new round of quantitative easing. With the liquidity rules and banks’ concerns over loan losses, much of the money ended up back as deposits at the Fed, not as loans.
For regulators and banking institutions, the question remains how much capital should be held as reserves and not lent out without hampering economic growth. In 2019, the total amount held as cash was $3.2 trillion ($13.3 trillion in deposits minus $10.1 trillion in loans). Too much capital reserves could slow down the economy, while too little could make banks riskier and more prone to failure. It’s a very delicate scale weighing the factors of too much and too little liquidity; one that could be addressed following the end of this recession.
Staying on the topic of the banking industry, the largest banks are starting off Q1 earnings season this week with JPMorgan and Wells Fargo on Wednesday, and Bank of America on Thursday. Many analysts are very optimistic this earnings season, as indicated by significant positive adjustments to earnings estimates. Expected earnings growth among S&P 500 companies for Q1 today is 24% versus 16% just 4 months ago. Attention will also be on signs of confidence from corporate executives on rising consumer demand for their products. As the economy continues to reopen, we remain confident in our quality investments that have persevered. And for any attractive opportunities that may be overlooked due to the overly speculative trades monopolizing headlines, we’ll be keeping a close eye on them too.
As always, please don’t hesitate to reach out to your wealth manager with any questions you might have.
Stay safe everyone!
– Matt Kawashima