Author: Gregg Giboney, CFA, Timberline Investment Management
Covestor model: Dividend and Growth
Disclosure: Long JPM, GE
There have been a couple of recent developments worth commenting on.
The first one is JP Morgan and the $2 billion write-off they will be taking for a very poorly executed risk hedge. $2 billion is quite a bit of money but it only represents just over 1% of the company’s total capital and the company should easily earn the capital back in less than a year.
Relative to most other banks, JP Morgan still has greater capital after the loss. One of the desired outcomes of recent financial reform is for banks to have adequate capital to handle losses. This clearly appears to be the case with JP Morgan. The worst part of this is that it stokes fear of an overall banking problem. This is not the case. Bank capital ratios are strengthening and the underlying economy is slowly improving and helping to reduce credit losses. I think it is also interesting to note with JP Morgan that a roughly 1% hit to net worth lead to a roughly 9% decline in the stock price.
I think another way to look at this is to compare the event to what happened to General Electric (GE) about 3 years ago. About three weeks before an earnings release, CEO Jeffrey Immelt announced that the company would meet analyst earning expectations. When the release came out, earnings came up short and there was uproar about management abilities and Immelt in particular. Today, the event is largely forgotten and Immelt is generally held in high regard. At the time of the incident, Immelt probably made some very strong recommendations that if you want to continue working at GE, you will never let something like this happen again.
I have a feeling the same warning has been made by CEO Dimon at JP Morgan. While the bank looks sloppy now, it may have a pretty clean operating record moving forward with the mentioned fear-factor playing a big part. As always, bank outlooks are subject to economic developments. In this case, this does not look like an economic related issue – it looks like an operating issue.
This is not an investment recommendation for JP Morgan. Any investment recommendation needs to also take into consideration valuation and other fundamental factors which are not part of this report. The intent of this write-up is to convey my opinion that there has been a deficient portrayal of this incident in most news coverage.
The second item to talk about is Greece. Following recent elections, I have a hard time seeing Greece remaining in the European Union. Greece does not appear to have the stomach for sufficiently higher taxes or austerity to get the job done. The next alternative is to devalue their currency that is not possible with the Euro being their currency. Greece may hang on if the EU, and Germany in particular, are reluctant to realize a massive loss with a Greek default. To avoid this, the EU/Germany may continue to throw more good money after bad but I cannot see that lasting for an extended time period. It is not a pretty situation and currency conversions are difficult, but Greece is not a big player either. Spain and Italy are bigger and more consequential with a fear that if Greece goes, Spain and Italy will soon go as well. My best guess for now is that we won’t see a cataclysmic event but we may see a very meager economic decade for Europe.
I hope you found this to be helpful and thank you again for your business and interest in Timberline.
Gregg Giboney
