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

March 19, 2018 ~ Patrickhdjones ~ Leave a comment

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

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

March 14, 2018 ~ Patrickhdjones ~ Leave a comment

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.

UBS say Worries on China’s Debt are Overblown as it Sets Up Exclusive Investment Fund

December 1, 2017December 1, 2017 ~ Patrickhdjones ~ Leave a comment

Swiss banking giant UBS is introducing a new private fund for institutional and high net-worth individuals with an interest in investing in China’s booming equity markets.

Having obtained a new permit granting them increased access to stock markets in the country, UBS is introducing the first mainland China stock fund owned by a company outside China. The UBS China Equity Private Fund Series 1 has completed it’s initial offering, and will help its members to invest in China’s thriving stock markets, which for many years were available only to Chinese citizens.

China’s markets are dominated by state-owned businesses, but private companies are starting to make headway too, particularly in sectors like healthcare. Not only this, but the central government has made reforms in order to let foreign investors trade on more-restricted stock exchanges like the Shenzhen and Shanghai exchanges (which contain so called ‘A-Shares’ – the stocks that this new fund from UBS is mostly interested in).

Historically, these shares were only available for purchase by mainland citizens, due to China’s skepticism about foreign investment, but the country is continuing to open up its markets to overseas wealth.

UBS has a long history in China. UBS AG was China’s first qualified foreign institutional investor, as approved by the China Securities Regulatory Commission in 2003 – a massive deal for a foreign bank!

The fund’s manager, Zizhen Wang, said “From a long-term perspective, UBS sees sustainable growth in the Chinese economy and opportunities in the A-share market,” he added, “Blue-chip stocks are fairly valued and leading companies across numerous sectors are enhancing their international competitiveness.”

In another vote of confidence for the economy, UBS also said they were less worried about China’s debt burden than other banks. Speaking to Bloomberg, Jason Bedford, a Hong Kong-based UBS analyst, said a financial systemic credit event in China is “very unlikely”. He added that a lot of the items on China’s balance sheet were less risky than many thought, even the asset-backed securities.

He said “A significant portion of off-balance sheet exposures are composed of benign, no-risk or low-risk items.” He added, “The failure to distinguish the risk between these items has often led to an exaggerated risk perception among many market watchers.”

It’s no secret that the Chinese economy is hooked on debt, especially in its state-owned enterprises. Lending in the country has grown rapidly over recent years, as household and corporate wealth has ballooned. China’s citizens and businesses have been looking for higher returns in a system where bank interest rates have been held down.

The government is aware of this, and looks to be taking steps to deleverage the economy by cracking down on certain problem-areas, including the booming online lending market.

Just this week, CNBC reported that a top-level Chinese government body issued an urgent notice on Tuesday to provincial (local) governments, urging them to suspend approval for the setting up of new internet micro-lenders. They also apparently told local regulators to restrict granting new approvals for micro-loan firms to conduct lending across regions.

These kinds of businesses have grown massively in popularity over recent years, by giving credit to people who couldn’t get loans at state banks, which tend to favour bigger corporate clients instead.

Xi Jinping has made clear that he backs the idea of deleveraging so as to ‘cleanse risk’ from China’s financial system, and the governments actions so far have been applauded by analysts. But though reforms are clearly in motion, whether this will be enough to offset China’s already hugely leveraged economy is less certain.

As we saw in the case of the financial crisis in 2008 where top Wall Street firms were leveraged (indebted) to an obscene degree, a high amount of total debt can signal systemic financial fragility. When everyone owes everyone else money, a negative shock to the economy, or even just a spontaneous panic can upset the system, by causing a lot of borrowers to default at the same time. When financial firms are highly leveraged, it also makes it easier to have a bank run or a similar liquidity crisis. During the financial crisis, this was certainly the case. China must avoid this kind of situation at all costs.

Though UBS are bullish, other data shows the future looks bleak for the world’s second largest economy. Bloomberg economists Fielding Chen and Tom Orlik estimate that China’s total debt will reach 327% of GDP by 2022, a staggering level which could make it harder for the country to avoid a financial crisis, especially considering actual economic expansion is set to slow to 5.8% in 2022 from 6.7% in 2016, compounding matters further, and as growth continues to slow while debt continues to rise, the risk of a collapse in asset prices looms. This would spell big trouble for an economy that the world depends on for so much.

Patrick Jones

Brexit Woes Pile on Top of Poor UK Economic Data

October 20, 2017October 20, 2017 ~ Patrickhdjones ~ Leave a comment

THE DATA

UK retail sales fell by 0.8% in September according to the latest data from the Office for National Statistics.

As expected, inflation in the country is having a direct impact on the retail sector, as the ONS also reported that prices in shops have risen by 3.3% over the last year – a jump not seen since early 2012.

Consumer spending has been a key driver of growth recently, so this pull back will be seen as a concern, and possibly a factor the Bank of England will keep in mind as it debates over whether to raise interest rates.

All of this bad news is putting downward pressure on the Pound once again. Sterling reached $1.3226 against the Dollar yesterday but plunged this morning.

There is likely to be more volatility in the British currency as Brexit negotiations are in difficulty according to reports. The odds of Britain walking away without a deal from the talks have grown recently, with fingers pointing at both ineffectual Conservative leader Theresa May and the rigidity and stubbornness of the EU’s negotiating team.

THE POLITICS

In a move that may help to smooth negotiations, the Conservative Party has officially announced it will be assuring the right of EU citizens to remain in the UK after Brexit officially happens (and at this rate there’s plenty of doubt over whether it will happen at all). However the question coming from opposition leaders is: why did it take so long for them to do this? We don’t have an answer to the question, but it is yet another example of sloppiness on the part of the Tory party, whose stance on the negotiations in Brussels and Strasbourg and the future of the EU-UK relationship appears just as confused as their opposition in Parliament.

Speaking of which, the Labour leader Jeremy Corbyn employed a machiavellean tactic today by turning up in Brussels earlier than Theresa May and addressing a gathering of European Socialists, putting on a display of political theatre in order to undermine her position. After being introduced as ‘the next prime minister of the UK’, Corbyn called for the current PM to stand aside and let him take up negotiations, setting out his vision of a Brexit which maintains free access to the single market.

Of course, as anyone who has followed the referendum narrative knows, you can’t stay inside the single market and have Brexit. The two positions are entirely contradictory, for remaining in the customs union means conceeding to the laws that the European Union dictates, while Brexit means leaving all EU institutions, including the single market, European Court of Justice and so on. As a man who was once a noted Eurosceptic amongst the Labour back-benchers, it frankly seems naive for Mr Corbyn to expect such a favourable deal which lets the UK pull out of the Union yet retain tariff-free trading with the EU’s member states. Frankly, his words ring just as hollow as Theresa May’s call for a ‘close’ relationship with the EU. Neither of the leaders seem to grasp the fact that the Union is built on protectionism and not ‘fairness’ as they would so hope.

Indeed, the view from the continent arguably looks as if the EU Commission is trying to keep Britain subdued, as can be seen by the fact they are staunchly against letting the UK discuss the future of its trading relationships with the EU and the rest of the world for the time being – effectively sticking a roadblock right in the middle of negotiations. The EU is totally transparent in its interests. The bloc’s chief goal is its own survival and the promotion of ever closer union. Trying to have a sensible, logical and rational negotiation with such an organisation was always going to be difficult.

But it isn’t just the EU Commission that Theresa May’s Brexit team must be wary of. British members of Parliament are trying to derail the process. 18 Labour MEPs and one from the Liberal Democrats supported a European Parliament resolution critical of the British government’s approach to the negotiations, which said Brexit talks should not move on because insufficient progress had been made on divorce issues. This position is not a surprise, given that many Labour party members have difficulty accepting the outcome of the vote on June 24th last year, and never wanted a referendum to be held at all. Though they may pretend that the reason they attempt to block progress is due to wanting the government to be more accountable, in this writers opinion they are simply hoping to stall negotiations and hopefully force a rerun of the referendum, despite their protestations to the contrary. The EU is no stranger to reruns of this nature. Ireland rejected the Lisbon Treaty in 2008 but the decision was ultimately overturned.

Now that the fifth round of monthly Brexit talks between the UK and the EU has taken place, a decision is due to be taken by the EU later in October on whether or not enough progress has been made on “separation issues” to be able to start talks about the future relationship between the bloc and the UK post-Brexit. Refreshingly, German Chancellor Angela Merkel said there were “encouraging” signs that the Brexit talks could move on to the subject of the future trade relationship as early as December, according to The Guardian today. For the time being however, investors will be hoping for more clarity and a faster negotiation progress from the Commission and the British Government, but it looks like they will be waiting quite a while longer.

Losses for the Pound (seen here against the Euro through 2017) have helped the FTSE100 to rally throughout the year. With this being said, stock market performance is not 100% correlated with economic prosperity. The reason that the FTSE, as well as the Bats Low 50 index have outperformed despite the woeful Brexit situation is simply because firms within these indices make much of their profits overseas.

A cheaper Pound allows consumers in other countries to buy their goods for less, improving company profits. In strict contrast, the Bats Brexit High 50 index has underperformed. The Bats Brexit indices were designed to act as barometers for assessing how Brexit is impacting UK companies. They do this by analysing the difference in performance between companies that generate a large portion of revenues in the UK and those that have less revenue exposure to the UK. The High 50 is made up of companies that depend more upon domestic revenues for success, while the Low 50 is those that primarily generate earnings overseas. You can clearly see the discrepancy between the performances of the High 50 (in red), FTSE100 (in yellow) and Low 50 (in blue) indices this year here.

Why should I diversify my investment portfolio?

July 7, 2017July 7, 2017 ~ Patrickhdjones ~ Leave a comment

Shortly before the financial crisis rocked the world economy in 2007/8, optimism amongst US policymakers was high and widespread.

On June 2nd 2005, only 3 years before many of the worlds largest financial institutions were on the brink of insolvency, Christopher Cox stood in a room full of reporters. Cox was the new Chairman of the Securities and Exchange Commission or the SEC, under the Bush administration. The role of the organisation was to protect investors from foul play in financial markets, ensuring a level playing field between customers and asset management firms.

After his public introduction from President Bush, Cox took to the podium to set out the responsibilities of his new role and the state of the economy. He praised the financial sectors contribution to US economic growth, saying “In this amazing world of instant global communications, the free and efficient movement of capital is helping to create the greatest prosperity in human history.”

Statement on the Economy. Rose Garden — Chairman of the Federal Reserve Ben Bernanke, President George W. Bush, Secretary of the Treasury Henry ‘Hank’ Paulson & SEC Chairman Christopher Cox in the White House Rose Garden. September 19, 2008.

Little did he know what was around the corner, but of course, no one really knew what was coming. Even the Chairman of the Federal Reserve, Ben Bernanke said in January 2008, “The Federal Reserve is not currently forecasting a recession.” It turned out that the SEC and other bodies that were supposed to protect the interests of investors, had stood by while banks were taking greater and greater risks and engaging in dangerous behaviour. Banks were taking enormous risks in the derivatives market, trading highly complex financial instruments like CDOs (collateralised debt obligations) and MBS (mortgage backed securities). Banks were also highly leveraged, which meant they were borrowing huge sums in order to take part in this kind of activity. There was a get-rich-quick culture pervading the financial sector. In this era of widespread irresponsibility on the part of some of the most famous investment management firms in the world, selling more toxic products to unsuspecting investors meant bigger bonuses. As such, it led to the eventual meltdown.

The damage was more serious that anyone could have imagined. In those years, investors lost life savings, while millions of ordinary citizens became homeless and unemployed, in a financial slump that left no country on the planet unaffected.

2935021856_7a8740b0a1_b (2) — Headline montage from media during the peak of the crisis

Why am I talking about the crisis? Well, it’s merely an example to highlight potential risks and why you should hedge against them as much as possible. Risk is a major factor to consider when choosing what to invest in. Financial markets are entities which are linked to human sentiment. Even if the crowd and the talking heads think they are ‘right’ about the way a price, or a company, or interest rates are heading, markets are still, (in the words of billionaire investor George Soros) “inherently unstable”. Due to this instability, it makes sense to hedge your bets and spread your risk across different sectors, asset classes and types of markets when investing.

Financial markets are all interconnected. Even the largest blue chip stocks which we hear about every day are not immune to external forces which can weaken their fundamentals. Geopolitical circumstances out of your control can cause huge sell offs in a single day, putting your portfolio at risk. Perhaps a war breaks out in Asia and suddenly every stock index from Tokyo to Shanghai loses a ton of its value, for example. Even shiny new instruments like cryptocurrencies which are currently all the rage have been known to lose hundreds of dollars off their value in a single trading day. Yes, it would be nice if markets were predictable and human behaviour was also less impulsive, but this sadly is not the case.

How do I diversify?

Diversification is a form of risk management, but it is also a tool you can use to make money as well.

The idea behind diversifying a portfolio is that investors will be less affected by an event that has a strong impact on a particular industry, company or type of investment. Not putting all of your eggs in one basket is another way of thinking about it.

By ensuring you invest in a multitude of sectors and asset classes, you can be more shielded from external shocks to the market (like geopolitical circumstances, economic downturns and the like).

By keeping investments split into different asset classes, (by choosing varying position sizes in different sectors) investors can become fairly well hedged incase of any destabilising news which will cause prices to fall.

Even if the flavour of the month is a bluechip giant in the S&P500 and every analyst seems to be singing it’s praises, going all in on the stock or similar companies within the same sector can be a foolish decision. Trends come and go frequently. Sectors lose steam, indexes that were once riding all time highs lose their edge. We saw recently how a political crisis in Brazil which engulfed the country’s leader Michel Temer, ignited a huge selloff in Brazilian stock markets. The key Bovespa index saw it’s biggest fall in almost 9 years on the same day corruption charges surfaced.

It is not possible to do away with all risk, but by hedging your positions and keeping your risk spread across different kinds of instruments, you can keep protect yourself against large-scale losses and maintain your well earned gains.