The Market Blows More Smoke At The Fed

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Includes: DB, GS, JPM, WFC
by: Kurt Dew

Summary

The domestic stock market has been volatile and trending downward.

The performance of economies outside the US has been poor.

Other factors, such as the banks, and falling oil prices, concern the market.

There is no evidence that these things are significantly affecting the economy at large.

They should therefore not affect monetary policy.

I wake up to JP Morgan (NYSE: JPM) saying "It's hard to imagine an uglier morning." And the market tanks. The Fed should ignore this event. It has no implications for monetary policy or the US economy, yet.

Click to enlarge

It's a bad day.

Let's consider the factors.

  1. China is finding a total change from an export led economy to a domestic consumption demand economy difficult.
  2. The Persian Gulf countries are currently competing with each other to see who can sell the most crude oil at the lowest price.
  3. Russia's economy is tanking.
  4. Every major economy other than the United States is pumping easy money into their economies at a furious pace.
  5. The dollar is strong.
  6. Unemployment is falling.
  7. Housing is up.

If that is all bad news, what does good news look like?

Granted. The US economy has a few problems.

  1. The US banks are tanking more than other firms.
  2. Leveraged oil producers are in desperate financial straits.
  3. China. You can read my thoughts on China here.

The banks. Where's the surprise? Even a superficial reading of the big US bank's quarterly earnings announcements makes it clear that the current plan [excepting Goldman Sachs (NYSE: GS), and Wells Fargo, (NYSE: WFC)] is as follows:

  1. Stop losing money with risky trading.
  2. Stop losing money with risky lending.
  3. Hold enormous amounts of the Federal Reserve's cash.
  4. Do complex math to decide for yourself what your portfolio valuations and risks are.
  5. Explain these results to nobody but government mathematicians, who explain that the banks' measures of their risk cannot be compared.

And the market is surprised when the dealer bank shares sell off?

Granted, the European banks are a different, far uglier picture. They figured no one was watching when they did very little risk adjustment in response to the Crisis of 2007. They let the US banks take the heat. The European banks observed that their European regulators were going to give them time to make the necessary adjustments.

European regulators are excellent that way. They don't get frantic. Everything in due course. Think it over. Eight years is not enough time.

Other than observing that risk mitigation has been totally inadequate, the European banking system defies analysis and prediction. There are too many moving parts.

A few things are different there than in the United States. There is a long history of very large banks. Historically these banks were plodding servants of the equally big corporate borrowers. All under the government's watchful eye.

When the market for corporate borrowing dried up, many decades ago, these banks never adjusted. They took the easy way out. They literally bought whatever the US banks were selling and did whatever the US banks were doing.

Money and government are very tight in Europe. This has important implications. If a bank is an important national symbol - the classic case is Deutsche Bank (NYSEARCA: DB) - it can stumble and fall. It can misbehave. But it will never go away. As long as there is Germany, there will be Deutsche Bank. And the Continent's governments tend to bail out the debt-holders for large businesses in distress.

Deutsche Bank is Germany's Largest.

There is just no avoiding the observation that the large French, German, and Swiss banks are not well managed. That may change, but I have been thinking that for decades, and I have been wrong. I have, over the years, reached a fatalist conclusion:

No matter how earnest a bank is, no matter how sincere its desire to change, if the bank is absolutely certain that it will be bailed out when it fails, it will get sloppy, undisciplined, and too risky. The crucible of possible failure is the only way to temper a steel-willed banker.

In the United States, the crucible is cooking. Something good will ultimately come out of it.

So my suggestion: investors should stick to what they know. If you don't know on the Continent, avoid investing on the Continent.

To summarize the banks:

  1. The US banks are in the doldrums. Their old loan-packaging, shadow-banking, methods are unacceptable, at the moment. But they have no new ideas. That's not good, but it's not the end of the world. I am not in the stocks. Any of them. The country is over-banked and out of ideas. Wait it out. They'll come up with something. There will always be high-quality US banks. But at the moment, it is a difficult environment.
  2. The European banks are in the midst of an identity crisis. Europe itself is in the midst of an identity crisis. Think twice about investing in European banks.

Leveraged oil companies in the United States. Again, I just do not understand the surprise. If the banks' situation is no surprise, the leveraged oil producers are drunken sailors. Remember Penn Square? Continental? Texas Banking Crisis?

Oil prices don't simply rise. They fall, too. The global oil industry's largest players include religious fanatics in the middle of a proxy war. The industry includes Russia and Venezuela. And your business plan doesn't include the possibility of $20 crude? I am without pity.

Monetary Policy Implications. There are simply none.

  1. Monetary policy won't change the banks' business plans for the better.
  2. Monetary policy won't transform China's economy.
  3. Monetary policy won't reform the European banking system.
  4. Monetary policy won't resolve the problems of the Middle East, Russia, and Venezuela.

The Fed's responsibility is stable inflation and low unemployment. Until there is evidence that these objectives are at risk, the rest is noise. And there is no professional consensus that this moment has arrived. Last year, the Fed delayed, based on economic "noise." Let's not repeat that mistake.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.