Politics continued to dominate headlines again last week and over the weekend. Be it President Trump’s COVID diagnosis and recovery to the canceled debates and stimulus talks. Despite all this noise, equity markets have regained their momentum and finished another week higher. All the political news is masking some important market news including this week’s start to a busy earnings season. At first glance, it might be shocking to learn that corporate profits are expected to fall 20% this quarter, compared to prior year numbers. But that is an improvement from the 32% and 25% declines we saw in the past two quarters. The trend is clearly moving upwards and that is good news for investors who have been extremely patient in the past quarters. They have been overlooking the devastation caused by COVID and looking towards the future.
One of the first groups of companies to report will be America’s big banks. Banks are an interesting group. Gone are the simple neighborhood banks that offer a place for you to park your hard-earned savings and borrow when you want to make large purchase like a car or home. They are now diversified conglomerates. While many still offer the basic home and auto loans we all need, they have evolved into so much more. But where the real money lies is helping their clients on more exotic types of loans, or other ways to raise cash. Most large banks focus on giving advice to their institutional clients (other large companies). Helping companies raise money in the stock or bond markets is quite lucrative. Modern banks have also taken on other businesses and specialties. Some have pursued less risky activities like wealth and asset management. One such bank that has pushed this approach is Morgan Stanley (MS). They have been focusing more on wealth management since the Great Financial Crisis. After recently closing on their deal to buy online brokerage house, eTrade, it is now in the market to purchase money manager, Eaton Vance.
But at the core, banks big and small are lending operations. They may derive profits from other areas, like trading and investment advice, but most are highly dependent on the business cycle. During boom times, their banking clients are flush with cash and profits, so the machine is running smoothly. But during downturns, those same clients can turn into liabilities for the bank. Be it the 24-year-old unemployed waiter that has $5k in credit card debt to the restaurant owner that has seen his revenues drop by 90% because they’ve been closed for six months now. To account for the upcoming defaults, banks have been setting aside cash (or “reserves”) at stunning rates. Major banks have now set aside almost $250 billion to account for losses, almost as much as back in 2008. How much more the banks set aside for losses this quarter will be an important indicator to watch.
Politics will continue to dominate the national headlines, probably well past November 3rd. The noise from the right and left might even get louder after the election. But as we know, investing in the markets based on political ideology is not a good idea. We’ve covered that in the past few articles, so I don’t want to sound like a broken record. But if investors just focus on politics, they will miss a lot of crucial data over the next few weeks that could have a bigger impact on their portfolios. Thus, we’ll refrain from investing based on political ideologies and continue to monitor our watchlist of quality companies for when they reach attractive valuations.