I can not believe the media is still touting the London Whale event over at JPMorgan Chase (JPM). I think the media is overly exaggerating the negative consequences of the derivative losses that were made by JP Morgan and Chase. One example of this is Kate Kelly from CNBC:
"London Whale" trade, as the series of corporate-credit derivative trades that led to at least $6.2 billion in losses last year have come to be called, "provides a startling and instructive case history of how synthetic credit derivatives have become a multibillion-dollar source of risk within the U.S. banking system."
I understand the error in judgment the bank's traders made at the prop-trading desks and that $6.2 billion is a large loss for a bank of JPMorgan's scale to absorb. However, I also believe that these losses should be put in perspective so as not to cause any unnecessary concern for stakeholders. This can be backed by the large cash flow the company is still able to generate from current operations.
The company has been able to, consistently improve its cash from operations which can be shown by the upwards sloping trend line. The cash from operations was $25.08B in fiscal year 2012. Meaning that the business is still able to generate profits from its operations despite all the negative speculation over the London Whale losses and how it may affect the company going forward. There are many reasons for why investors should remain optimistic on the long-term prospects of the company going forward.
- Declining loan losses, believe it or not the company has set aside less capital in anticipate of future loan losses. This means that the whole "shadow inventory" scare is really coming to a close as loan loss allowances declined from 5.04% in 2009 down to 3.84% in 2011. This trend is likely to sustain itself, and it should be a positive indication of future growth going forward.
- The economics backing banking is becoming better. The American population continues to grow by 3 million people each year, remember, more people need to buy homes in order to leave their current household. Household formation is expected to go up, and with only 845,000 houses being built annually per year, there is a huge housing shortage. The difference between the 845,000 houses being built versus household formation that are projected to be at 1,200,000 according to economist estimates. This means further lending opportunities for Chase bank.
- Chase relies heavily on cross-selling financial products. Almost every financial product can be bought from Chase. Research, analysis, asset management, credit cards, debit cards, loans, and etc. The bank is emphasizing improved customer service in order to increase the profitability of the bank. This strategy makes sense because banking and financial services have an elasticity rating of 0.56. Meaning that customers are less price sensitive. Putting this in perspective, very few customers go out and shop for the highest interest rate on CD's, the lowest interest rate on a mortgage or look for the lowest fees charged by a bank. Customers buy financial products based on preference, which is why banks can increase prices by 10% and anticipate a decline in demand of 4.4%. This could allow Chase to further maximize profits through price increases.
The SPDRs Select Sector Financial ETF (XLF) has been on a continuous up-trend. The asset management's sector allocation strategy seems to aim towards the financials and less towards other sectors of the economy. The underpinning economics, plus the cross-selling opportunities banks have to further leverage their pre-existing sales force, seems to be one of the main reasons for why investors invest into banks.
The XLF has broke above the symmetrical trend line implying that the whole financial sector may be long over-due for a longer-term up-trend. I believe the banks are a great place for investors to park their capital.
The recent decline in JPMorgan's stock price is likely to be temporary. As the media over-played the possibility of additional fines on the bank. Even, if fines were levered against the bank, it would not have substantial reputational damage as I can assure you every major bank on wall street hasn't escaped regulatory scrutiny/class actions law suits whatsoever. It's a matter of comparing one bad apple versus the other, not a matter of which one looks the best among the batch. That being the case I anticipate the stock to continue to rally after the momentary media hysteria which caused a sudden decline in the price of the stock.
According to Kate Kelly JPMorgan could be hit by some regulatory heat:
Levin and other subcommittee members will gather at 9:30am ET Friday on Capitol Hill to question JPMorgan executives as part of a day-long hearing on the London Whale debacle. Drew will be a star attraction, along with Braunstein and Thomas Curry, the Comptroller of the Currency.
I really have to put this in perspective and say, so what. It does not matter whether people go to jail on this one, the media have overplayed all the mistrust Main Street should have at Wall Street that the investment community plainly doesn't care anymore. Investors are chasing yields, and the financials are still providing them. Overall I remain highly optimistic on JPMorgan Chase despite the repeated pretense the media puts up over the regulatory issues banks continue to face.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.