Undercooked

Undercooked.  Stocks fell slightly yesterday as traders were underwhelmed with the mini trade deal announced on Friday.  Traders were looking for something positive to follow Friday’s rally but came up short because whatever details exist on the Phase 1 deal seem fragile.

MY TWO CENTS

1.  What is a bank to do?  Today is the big day.  Third Quarter Earnings season officially begin with the banks.  2019 has been a rough ride for the banking sector.  Lower interest rates, a delicate IPO market, and foreign lending struggles are just a few of the challenges faced by the big banks.  A bank’s core business is lending money.  They borrow money from you and in time deposits (such as CD’s), savings accounts, and money markets. They then loan out that money for longer terms in mortgages, auto loans, or commercial loans to companies.  The difference between what they pay and what they receive is their net interest income.  With a flat and inverted yield curve banks have been struggling to maintain healthy margins.  On the upside, lower rates have incentivized borrowers to take on more debt, so increased lending has partially offset the lower margins.  Basic lending is not the only way banks make money.  Larger banks get deeply involved in commercial lending which is far more complicated.  The good news is that there are lots of fees involved.  The bad news is that the banks are often exposed to significant risk as a result of the complicated deal structures.  When a fast growing company seeks to go public they often rely on commercial lenders to provide bridge loans to cover cash requirements until the IPO and beyond.  When the company goes public, the loans are often repaid or morph into a different type of loan.  From a bank’s perspective they are initially taking a short term risk that a rapidly cash burning company will successfully IPO and pay back the loan.  If the IPO fails or is priced significantly lower than expected, the banks can end up in a bind.  Looking back on this year’s underwhelming unicorn IPO’s one wonders what it means for big banks.  We will certainly find out starting today.  We can also get some further insight into commercial lending and capital markets by watching the WeWork saga unfold.  Its failed IPO attempt has left the company struggling for cash as they work with large investors and banks.  JP Morgan will kick off earnings this morning and they are working with WeWork to well, work things out.  The package reportedly involves a junk bond offering.  How do we know it’s a junk bond?  The package will reportedly include $2 billion in an unsecured 15% PIK bond (really risky for investors).  The bank will get fees for that offering but will most likely continue to hold risky credit facilities for the balance of the $5 billion dollar package.

2.  Devil, always in the details.  One couldn’t help but notice that there was a great deal of positive expectation built up leading into Friday’s negotiation.  Perhaps a bit too much.  We expected some sort of partial deal, but had no idea what “partial” meant.  The President announced the “phase 1” deal just as the market was closing leaving traders very little time to assess the facts.  Over the weekend, we learned that there were, actually… no facts.  Reportedly there were no notes taken either.  Hmm.  Well there was a handshake in the oval office, and that looked good, on the surface (we have seen those before).  China is buying farm products but my regular readers know that I am constantly harping on the fact that they are only doing it out of desperation.  It didn’t take long for more details to emerge.  Yesterday morning I reported that China was demanding further talks before any official deal could be signed.  Early this morning WHILE YOU SLEPT, reports surfaced that China was requiring the US to completely eliminate $50 billion in tariffs in order for it to make the farm product purchases linked to the phase one deal.  That is not what we heard on Friday which only halted a further hike in tariffs due to take effect today.  Though not surprising, these developments warrant continued vigilance as further details emerge.  The good news is that earnings season starts today and will most likely keep traders’ attention off of trade… for now.

THE MARKETS

Stocks closed slightly off yesterday as investors had a chance to review the phase one deal over the weekend.  The verdict?  Underwhelmed.  The S&P500 fell by -0.14%, the Dow Jones Industrial Average slipped by -0.11%, the Russell 2000 dropped by -0.43%, and the NASDAQ Composite Index traded off by -0.10%.  The bond markets were closed yesterday for Columbus Day.

WHAT’S NXT

– Earnings Earnings Earnings.  United Health Group, JP Morgan Chase, and BlackRock all beat earnings this morning.  We will also hear from Schwab, Citigroup, Goldman Sachs, and Wells Fargo before the bell.  After the bell earnings include United Airlines and JB Hunt.

–  Atlanta Fed’s Raphael Bostic, Kansas City Fed President Esther George, and San Francisco Fed President Mary Daly will all speak today.

daily chartbook 2019-10-15