The US Senate has voted to roll back Dodd-Frank rules for banks – what does this mean?

Last week the US Senate passed a bank deregulation bill that would begin the process of rolling back parts of the Dodd-Frank Wall Street reforms, passed during Barack Obama’s tenure. The original bill in 2010 placed restrictions on banks in order to try and prevent another meltdown like the world had seen during the financial crisis.

The new bill passed with 67 votes to 31, but was met with stern opposition from house Democrats, who argued that Republicans were undermining financial stability by voting in favor of reducing rules for lenders.

The new legislation would raise the threshold at which banks become subject to tighter oversight. Under the original Dodd-Frank act, a bank with assets greater than $50 billion is subject to stricter regulation, including stress tests. Now though, the proposed legislation would raise that threshold to $250 billion, a change that affects 25 of the 38 largest banks in the country.

The change would mean mid-level banks such as BB&T would not have to submit to the Federal Reserve’s stress tests (which were designed to make sure a bank could withstand a major financial crisis). Specifically, banks with less than $100 billion in assets would be immediately exempt from the current SIFI rules. SIFI stands for a ‘systematically important financial institution’, one whose failure may trigger a financial crisis. This basically points to a large scale relaxing of the rules and limits on the behaviour of small and mid-level banks.

Crucially, the new legislation gives banks with assets under $10 billion and limited trading assets a pass on the Volcker rule. This rule was put in place to stop banks from using their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures, as well as other instruments. Derivatives in particular are known as riskier investments. 

The concern is that a rolling back of regulations (a common talking point for Trump in his speeches about the American economy) may lead to another financial crisis. The reasons for the crash in 2007/8 were many, but one key driver was deregulation in the financial sector before the crisis, which allowed banks to take on more and more risk, as well as becoming extremely highly leveraged.

It was a lack of oversight of the financial sector that encouraged banks to shift toxic financial products onto consumers, as well as between eachother.

The argument in favour of the changes to Dodd-Frank is that cutting red-tape could spur banks, especially local ones in smaller communities, to lend more, encouraging businesses and individuals to take on projects and generally put their money to work.

Some think the new changes to the bill are overstated. In a note to clients, Jaret Seiberg, an analyst at Cowen & Co said: “We believe this bill is broadly positive for regional banks and trust banks while offering little help to the mega banks.”

Whether or not the bill will really affect the bottom line of the ‘mega’ banks is yet to be seen, but it’s pretty clear investors think it will. Some big bank ETF’s saw record inflows this week. Bloomberg reported that 2 funds run by State Street Corp saw their biggest one-day inflows ever, with the SPDR S&P Regional Banking ETF taking in $606 million, and the SPDR S&P Bank ETF taking in $323 million, thanks to excitement about what deregulation could mean for bank stocks.

However we shouldn’t forget that these ETF’s have been on the up and up for the last year anyway because the Federal Reserve made clear it was raising interest rates, and that’s good news for bank profits. With 3 or 4 rate hikes forecasted for 2018, it’s unlikely investors will be disappointed.

Here’s the worry though – what happens if banks start taking on more risks again? What happens if the aspects of their business that involve trading riskier financial instruments get overlooked by regulators? The world economy is still only just recovering from a crash that was caused by the banks 10 years ago. It’s taken years of low interest rates, quantitiative easing and austerity measures to try and get markets back on an even keel. We are only just seeing central banks begin to talk about rolling back QE and start to push interest rates higher to ‘normal’ levels, yet now the Senate has decided to lower the safeguards 10 years after a crisis in which American households lost roughly $16 trillion in net worth.

Many will argue they have done so in error, but memories are short, and last year’s stock market rally has fuelled an irrational exuberance in the markets which has fuelled more risk taking. These changes to Dodd-Frank could undermine the system again before it’s even recovered, putting investors portfolios at risk.

The prospect of bank deregulation has helped financial stocks to rally over the last year, including JPMorgan Chase, Goldman Sachs, BB&T and Bank of America

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A tale of 2 construction stocks – Balfour Beatty announces major profit 2 months after Carillion collapse

While British construction services company Carillion collapsed in spectacular style earlier this year under the weight of its huge debt burden, another UK construction giant that worked alongside it has seen its shares rise (see below) after revealing record profits.

Balfour Beatty said today its annual underlying pretax profit had almost tripled to £165 million by the end of 2017, from £62 million a year earlier, as it’s construction unit bid more selectively to win profitable contracts.

The gains for the firm are a testament to the benefits of a prudent strategy in picking projects, as opposed to Carillion, who took on more than they could chew.

The Chief executive of Balfour Leo Quinn explained it narrowly avoided the same fate as Carillion by reforming its business in the past few years.

Quinn said to BBC Radio 4: “We had our own near-death experience three years ago – eight profit warnings, £600m cash outflow in nine months from the company. These results today demonstrate an amazing transformation and turnaround.”

The company, which is behind the Crossrail project, was directly affected by Carillion’s liquidation – suffering a one-off-loss of £44 million on the Aberdeen Western Peripheral Route project as a result of Carillion’s fall.

The stellar reversal of fortunes for Balfour Beatty comes as the UK’s construction sector contracted for the ninth month in a row in March.

Balf
Balfour Beatty (BBY) shares have risen throughout mid-March

The world economy is stronger but tensions are rising – a look at the OECD’s latest report

The OECD says the global economy will see its strongest growth in seven years in 2018 thanks to a rebound in trade and investment, though it also warned today that a trade war could threaten the recovery.

In its March 2018 interim economic outlook which used the subtitle ‘Getting stronger, but tensions are rising’, the organisation updated its outlook for G20 economies and raised its global growth forecast for 2018 and 2019 to 3.9 percent – the highest since 2011, from previous forecasts of 3.6 percent for both years.

The raised forecast is partly due to expectations that U.S. tax cuts will boost the American economy.

Here were the key positive takeaways from the report:

– Growth is improving or steady in most G20 economies

– Trade and private investment are bouncing back

– New fiscal stimulus in the United States and Germany will further boost short-term growth

– Inflation (a concern for Central Banks) is set to rise slowly

– Consumer confidence, particularly in BRIICS nations (Brazil, Russia, India, Indonesia, China and South Africa) has risen sharply

The key negatives and risks were as follows:

– Income gains, particularly for median and low income households have barely improved over the last decade

– Public and private debt in G20 nations is very high, with China leading the way at over 200 percent of GDP

– The pace of structural reform is slow, in emerging market countries especially

– An escalation of trade tensions would be damaging for growth and jobs

Regardless, the overall picture is healthier. Acting OECD Chief Economist Alvaro Pereira said: “We think that the stronger economy is here to stay for the next couple years,” He added, “We are getting back to more normal circumstances than what we’ve seen in the last 10 years.”

This is good news for investors the world over, as a more robust global economy will create a better environment in which companies can grow and expand more easily, boosting corporate results and shareholder returns.

Foreign investors move out of Indian stocks for now but future is brighter than ever for India’s economy

Indian stocks fell out of favor with overseas investors last month, with markets cooling slightly after a stellar 2017 performance. New data showed foreign institutional investors pulled out $1.5 billion from Indian shares in February, following the market correction in the U.S. which hurt global indices, on top of fears concerning the Punjab National Bank, which is at the centre of a $1.8 billion fraud case.

Gautam Chhaochharia, head of research at UBS Securities India said: “Our global strategists like Korea, Indonesia and Brazil the most.” He added: “A year ago, India was the market with least hassles in its path, but now, other emerging markets look better off in comparison.” Indeed, Brazilian and even Russian indices rode out the last month far better than their Indian counterparts. This Monday the NIFTY50 made a small recovery heading back to the 10,600 mark.

However these figures don’t tell the full story. Regardless of the recent blip in the equity market, India’s economy is still powering ahead as one of the fastest growing in the world, with plenty of praise being handed to the nations leader Narendra Modi for his implemented economic reforms which are making India more business friendly.

Indeed, India has plenty of reasons for positivity on the economic front. The country has vast supplies of natural resources which are relatively unexplored, and also has a huge need for new infrastructure projects, not only physical, but also in terms of digitisation due to its massive rural population. This presents major opportunities to foreign investors seeking to take advantage of a rapidly developing emerging economy. As digitisation expands it will bring benefits not least to these more isolated communities but also to foreign companies, because more access to the internet will draw in more and more e-commerce customers, a trend which Walmart has already taken an interest in. In 2013, India had 30 to 40 million internet users, while today the number is estimated to be over 400 million. Once again, these shifts will undoubtedly be a major pull for overseas investors.

On top of this, India has a flourishing middle class. By 2020, India is projected to be the world’s third largest middle class consumer market behind China and North America. By 2030, India is likely to surpass both countries with consumer spending of nearly $13 trillion. The Indian population’s interest in investing in stocks has also grown exponentially – domestic mutual funds got a whopping $20 billion in 2017, around double from the year before, mostly due to average (non-institutional) investors, who were looking to take advantage of the awesome stock market rally during the year, instead of sticking with more traditional choices like gold or real estate to put their cash into.

All signs point to a thriving economy in the long term. Indeed, the latest set of economic data for Q4 2017 showed India’s economy expanded 7.2 percent year-on-year for the period. That is well above the upwardly revised 6.5 percent advanced in the previous period and above market expectations of 6.9 percent.

Overall, whether foreign institutional investors are confident on Indian equity markets or not right now, the future looks bright. All of the fundamentals are in place which make India one of the hottest places on earth to invest.

India has a problem with its banking sector and it’s beating down equities

India is suffering from contagion in its banking system, with a mounting pile of non-performing loans, poor accounting standards and growing evidence of major banking fraud, unearthed over the last few weeks by government agencies.

India’s ratio of bad loans (as a percentage of total loans) is among the worst in the G20, just behind Russia and ahead of Brazil, Turkey and Indonesia, according to the IMF, though back in 2009 it was among the best in the world in this regard.

Standard & Poors Global Ratings said the recently detected fraud at Punjab National Bank underscores and urgent need for reforms in public sector institutions, with further losses for these banks being expected. Banking stocks were among the biggest fallers on the NIFTY50 last week, on top of significant monthly losses.

It’s an issue that the Narendra Modi’s Union government is taking steps to address. In October last year, the government unveiled a massive bailout plan to inject Rs2.11 lakh crore (equivalent to around $32.43 billion) into banks over the next 2 years to improve their capital positions. Stress tests conducted by the IMF last year on India’s 15 largest banks showed Indian lenders fell behind their emerging market peers including Indonesia, China and Russia in this regard. However it wasn’t all bad news – the IMF described 64 percent of the assets of the top 15 banks as ‘resilient’.

There are reasons to suspect that many more bad loans have not yet been accounted for. The latest corporate results from India’s largest lender (State Bank of India) showed the bank posted surprise losses of higher-than-anticipated bad loans, though officials from the bank claimed the worst is over.

The problems in banking have crept into the stock market too, unnerving foreign investors. If India wants to realise its true potential as an economy then the authorities will need to take a firm stance on the matter.

JPMorgan Co-President warns of 40% correction in stocks – is he too pessimistic, or bearish?

JPMorgan Chase Co-President Daniel Pinto thinks the stock market is set for a 40 percent fall in the next 2-3 years, a move down which would end up wiping out the last 2 year’s of gains in the market rally stateside.

Speaking to Bloomberg Television, Pinto said: “We know there will be a correction at some point”. He added: “We are at an interesting time. We are 2-3 years probably until the end of the cycle and markets are going to be nervous. Nervous to anything that relates to inflation, nervous to anything that relates to growth. And I think tariffs – if they go a lot beyond what has been announced – it is something that will concern markets about future growth.”

These are big ‘ifs’ though. Trump wont necessarily escalate trade action at a more rapid rate. Indeed, as you can read in the final paragraph of this article, the administration has left the door open for other countries to adjust their own trade practices in return for tariffs being modified or removed completely. If other nations including China stop flooding the market with so much cheap steel, helping the U.S. to address its colossal trade deficit, Trump may be willing to soften more, and this would be another major boon for the markets, which are already starting to benefit from the Republican tax reform package passed in December last year.

So much depends on whether trade relations deterioriate further, and whether other leaders including China’s Xi Jinping are willing to concede to a more aggressive U.S. trade policy, or fight back even harder. Given how much both countries depend on eachother economically, its more likely that both leaders will be pragmatic over the issue, but if they aren’t, then Pinto’s forecast could come true.

For now though, even despite worries concerning inflation, the speed of Federal Reserve interest rate rises, the withdrawal of monetary easing and the prospect of another major correction in the markets like the one we saw in late January / early February, stock prices keep rising and indices keep moving upwards. The chart below shows how quickly the benchmark S&P500 index is recovering after that sharp fall earlier this year, even with all the noise in the press about chaos in the White House and warning signs in the economy.

SP500

Robust financial results for American companies through the first quarter of the year show us that the underlying fundamentals of the U.S. economy are strong, which is why investors keep buying back in. By February 8th this year, 322 S&P500 companies had reported quarterly results during the latest earnings season, and 78 percent of them beat Wall Street estimates. According to Thomson Reuters data, that was the best rate of above-estimate earnings since Q3 2009!

Besides this, the latest labour market data released today showed the U.S. economy added 313,000 new jobs in February, the biggest gain since mid-2016 and a reflection of the strongest labor market in two decades.

Then there’s the North Korea breakthrough – whereby Trump is set to meet Kim Jong Un in May, the first ever meeting between a sitting U.S. President and sitting DPRK leader in history. If relations between the 2 were normalised, this would be a huge relief to Asian stock markets and those in the U.S. boosting investor sentiment even more.

Overall, I’d argue Pinto’s case looks a little bit too bearish considering the data we are working with right now, but anything could happen in the next year or 2.

China vows to retaliate to U.S. tariffs on steel and aluminium as prospect of trade war looms

The Chinese government in Beijing has confirmed it will retaliate if the Trump administration goes ahead with a plan to place tariffs on steel and aluminum imports from China and other nations including Brazil.

In the latest progression in tensions between the 2 countries, Wang Hejun, a senior official at China’s Commerce Ministry said: “If the final decision from the U.S. hurts China’s interests, we will definitely take necessary measures to protect our rights.”

He was of course referring to proposals drawn up by U.S. Commerce Secretary Wilbur Ross, who last week recommended Trump should impose tariffs on foreign suppliers of metals due to ‘national security’ issues, as well as unfair trade practices including steel ‘dumping’. Dumping is the process of keeping steel prices artificially low, which has the effect of pricing other producers out of the market. Republicans in Washington argue that this practice negatively impacts the ability of U.S. steel companies to compete, thus hitting communities in America which have depended strongly on manufacturing jobs, and have been decimated by the closure of factories, particularly across the rustbelt.

Trump’s more protectionist rhetoric on trade and his skepticism of globalisation resonated strongly with voters in these communities in 2016, yet this is an age-old problem that was a hot topic even under Obama. Even notoriously anti-Trump news outlet CNN formerly sympathized with his perspective. In a report in 2016, CNN said that the American steel industry was “being hurt by an unprecedented surge in unfairly traded imports, with record amounts of foreign-produced steel flooding into the United States. Cheap, subsidized foreign imports are taking steel jobs away.”

Whether these tariffs are good for the American worker is yet to be seen, because this is only the second salvo to be fired in what could become a full blown trade war, but it’s fair to say the ramifications of this action from the Trump administration will be significant, given that China produces around half the world’s steel. Trump has until mid-April to decide on whether to go ahead with the proposals, which would mark the second major action on trade after he imposed tariffs on solar panels and washing machines from the Asian superpower in January.

The move won’t be a surprise given the rhetoric Trump used during the campaign and in his first year in office. He’s set his sights on renegotiating everything from how much NATO members spend on their military budgets to coming down hard on Canada’s lumber industry, whereby the Department of Commerce set total import tariffs at above 20 per cent for most Canadian softwood lumber producers last November.

China’s Ministry of Commerce soon went on the defensive, and said the conclusions from a US departmental national security review of the steel and aluminium industries were incorrect, because China has proven its products did not threaten U.S. national security. Wang Hejun said: “The spectrum of national security is very broad. Without a clear definition, it could easily be abused. If every country followed the U.S. on this, it would have serious ramifications on the international trade order.”