If Aristotle were around today, he’d probably be a strategist or investment consultant.
That great idiom of his, “one swallow does not make a summer … similarly one day or brief time of happiness does not make a person entirely happy” should be emblazoned on the foreheads of all investors.
It’s certainly a highly apposite observation on the unrealistic, rather bizarre and exasperating short-term performance expectations they have of banks. It’s particularly true of European banks in the midst of strategy overhauls, those still in rehab and/or those simply trying to make sense of confounding and treacherous underlying market conditions.
That idiom applied to banking today would read: “one quarter’s earnings does not a strategy make”. Such thoughts were brought home to me yesterday in the wake of UBS’s fourth-quarter and annual earnings. By the standards of the previous three quarters, the Swiss bank’s earnings report was a clear outlier that undershot on almost all metrics. Period. No point in trying to mask it. On a blended annual basis, though, the numbers are still impressive.
Beyond an insatiable appetite for data to plug into their models, some in the analyst community were yesterday already calling for a new UBS strategy, pointing to weaknesses or casting aspersions on the current three-year plan. I saw analyst quotes showing a lack of understanding of why one quarter is great when another quarter is not.
Stupid
The answer is simple: it’s the market, stupid. Talking generally now and not about UBS in particular, the need for a strategic upgrade after a single quarter’s numbers is patently and unquestionably ridiculous. I’d even suggest that it borders on being dangerously negligent insofar as it fails to take into account a number of material factors.
Firstly, slow or slowing economic growth, and even contraction, depends on the country or region. Different parts of the world are at different points in the business cycle. China, emerging markets, oil, negative rates, sluggish trade flows and geo-political hotspots are wild cards.
Add that to a rapid decline in confidence and an impending sense of doom in the fourth quarter of 2015 and you have a recipe for eye-watering market volatility in early 2016, not to mention a sense of capitulation in terms of preparedness to trade and corporate and institutional distress.
That stuff matters to banks’ ability to perform, oddly enough, since they’re at the sharp end of it all.
The key question to overlay on all the above is whether a given set of conditions is likely to be a permanent feature of the landscape. A more nuanced version would be: is a given set of conditions likely to be a feature of the landscape for long enough for a bank to question its direction, re-think its plans and start running around the track in the opposite direction?
If the answer to either or both is “no”, it’s not question of strategy; it’s more a question of engaging tactics to withstand the effects of a potentially short-lived sequence of negative events, reining in your risk and trying as best as you can to optimise your costs. That doesn’t, by the way, mean a knee-jerk firing of producers who can accelerate upside on the other side of the storm.
Slaves to client-service
One of the secondary effects of banking regulation has been to force banks into becoming one-dimensional client-service machines with much less diversification of earnings. Sure, there are all sorts of benefits to that, from a governance and systemic risk perspective.
But without leveraged prop trading desks, without close alliances to rampant financial sponsors or hedge funds (where banks acted as co-investors or financiers), and with slimmer product portfolios and geographical footprints – all of which formerly acted as earnings counter-balances – banks today in their dual capacity of agency brokers and advisers may be more cost-efficient. But they’re tied in a much more binary fashion to the fortunes of their corporate and institutional buy-side clients.
The bottom line is that a lot more due diligence and industry context is required to really understand individual banks and their susceptibility or opportunity in the face of events.
Selectivity
Before the financial crisis, pretty much every major bank had a broadly similar strategy: to be global in terms of presence, product, currency and clients. That world has changed, and banks are carefully selecting where, with which products and with whom they can add value. That renders the investment proposition much more complicated but the pitfalls are obvious.
Imagine you had selected China and equities as core franchises, and had looked to build out your burgeoning US advisory franchise in oil and gas and part of that involved using balance sheet to get deals and clients through the door. Suppose you had de-emphasised or exited large chunks of FICC (because you didn’t think you could become a money-printing flow monster). Who would have questioned that a year ago?
On a sector-play basis, incidentally, energy and power saw almost US$600bn of M&A deal flow in 2015 (around 12.5% of the total and second only to healthcare), as well as US$440bn of debt and equity underwriting activity across oil and gas, petrochemicals, pipelines, power and alternative energy. That’s a chunky wallet to chase.
But how does it look now? Perhaps more importantly, how will that look in another year?
Sure, the banking industry has become a lot tougher to read. But selecting long-term winners shouldn’t be driven by analysts’ short-term stock-price forecasts or by investors looking to capture quarter-to-quarter out-performance.
Banks don’t – and shouldn’t - determine strategy on a quarter-to-quarter basis to please bank analysts or stock speculators. It’s a long-term game and investors should be making NPV judgements on the potential of the strategy to power earnings over cycles not quarters.
One quarter’s earnings does not a strategy make
