If my sole purpose were to write a review of the week I’d have to summarise it as not having been very pretty. Bond yields up, equities and sterling down, China all over the place, Wells Fargo’s John Stumpf out and Samsung up in flames… I think that more or less covers it.
Stumpf has fallen on his sword in ultra-slow motion but in doing so has done neither his own reputation nor that of the bank which employed him and made him a very, very rich man any good at all. According to the share register he is a top-200 shareholder and owns in his own name around 2,435,000 shares in the bank, which at the currently depressed price of US$44.75 still makes his holding worth over US$108m. That’s quite apart from any stock that might be held in a family trust or his other wealth, which I am sure is not inconsiderable.
To date Wells has only been fined US$185m, which fades into insignificance compared to the numbers that have been ponied up at those banks found guilty of mortgage bond mis-selling. I’m afraid I must briefly stand up for the mis-sellers. Right through the first decade of the new century shareholders put incredible pressure on banks to match or beat their peers’ performance numbers. I have often asked how long people at the time thought a chairman would remain in place had he, at an annual shareholders’ meeting, declared that his bank was delivering 200 or so basis points less return on equity on the basis that its board did not believe that current lending and distribution practices were morally supportable.
Regret
From Goldman Sachs to Deutsche Bank and all stations in between and from the lowliest unemployed single mother of eight with a mortgage on a trailer on the hurricane coast to the local commission-hungry mortgage broker in a polyester suit, everyone was locked into a value chain (or lack-of-value chain if you prefer) in which rational thinking and moral judgment had been lost. All of them, to the last cat and dog, were living out the American dream of getting rich by virtue of nothing less than living in the best country in the world, the land of the free.
The results were of course devastating in the biblical sense of seven fat years being followed by seven lean years. Yet despite all the damage that was done, I still somehow feel that the Wells story is worse. The financial crisis was the éclat at the end of a long but organic development that had lost its moral compass, which had gone off in the wrong direction and had blown up in everybody’s face. There was something deeply Darwinian about it all. The account creation scandal at Wells Fargo was not “of an age”; it was a very clear and deliberate fraud of the ilk of VW’s emission thing. It had nothing to do trying to keep up with the competition and had nothing to do with investors who were just as greedy and just as well-versed in the underlying mathematics as were the originators. It had more to do with conning the likes of the Sage of Omaha, Warren Buffett, who had condemned financial engineering as weapons of mass destruction but had lauded good ole’ high street banking as the nirvana of mom and pop and apple pie.
Fine time
US$14bn for Deutsche Bank and US$185m for Wells Fargo? If ever there was a question of moral compasses, it has to be with the chaps in the sorting offices at the regulator and criminal justice department who calculate what the monetary penalties for the respective wrongdoings should be. So chairman and CEO Stumpf goes and is immediately replaced by his heir apparent, Tim Sloan, who as COO was no further removed from the cesspit than was Stumpf. Should Buffett, owner of 10% of the bank and far and away its largest shareholder, not be up in arms here? Power corrupts; absolute power corrupts absolutely.
But back to the other events. The universal rise in bond yields this past week is seen by many as the end of the game. When I came into the business in the mid-1980s the long bond – nobody cared much about the 10-year in those days – was still paying something between 8% and 9%; even I was still at school when it peaked at 15.25%. Since then it has followed a fairly straight trajectory south. Sure it’s gone up and down by the odd 100bp along the way but the long-term trend has been incredibly stable. At the end of every sharp rally the end of the cycle has been declared, only for yields to continue to fall. The move from 4% to 2.5% - I’m still with the 30-year benchmark – has been driven by post-crisis monetary policy. Thus, if stimulus really is at the end and if a normalisation of monetary policy is upon us then, irrespective of where short rates are now, the long bond should begin an inexorable rise back towards its organic yield level of 4%. That 150bp adjustment translates into about 30 points in the bond price.
Substance
With yields so low and with the margin between positive and negative total return so thin, there is nowhere to hide if the entire yield curve begins to move north, whether parallel or in steepening mode. Were it not for the fact that every balanced investment portfolio holds bonds - whether overweight, neutral or underweight is a matter for tactical and not strategic asset allocation - I think demand might fade quite sharply. On the other hand, if equities were to suffer the much-vaunted sharp correction the bond end of the portfolio would be the one everyone would look to for stability. So, the call has to be to hold your nose and don’t take off the buying boots.
Alas, it is that time of the week again and all that remains is for me to wish you and yours a happy and peaceful weekend. Summer was late this year and so is autumn. It’s a good time to get out into the garden and to do some cutting back. I’m afraid that compensation committees will also be sitting down around now to do the same. For the lucky ones it will only be the bonus that is cut back. For others it will be their jobs. I spoke yesterday to the owner of a small hedge fund who tells me that the banks are also cutting back their counterparty lists and that he is on the chopping board for not having done enough business with them. Is that really all his fault? Are we making too little or are our expectations too high? I lost my entire organic cabbage crop – red, white and Brussels sprouts too - to some beasties this year. Does that mean that I’m planning to grass-over my veggie patch? Does it hell!