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Good morning. We’re still thinking about the Fed’s balance sheet and, judging by the responses to Wednesday’s letter, readers are too. This is a topic we will return to soon. Meanwhile: European value, bank shares and wildfires. Email us: firstname.lastname@example.org and email@example.com.
The value trade in Europe shouts
Value stocks are experiencing a good 2022. The Russell value index has risen 7 percent so far this year, beating Russell’s growth by 7 percentage points. This is a lot in less than three weeks. But Unhedged’s friend Duncan Lamont, who heads the research team at Schroders, points out that the value outbreak is even more extreme in Europe. The MSCI EMU value index has surpassed its growth counterpart by a whopping 11 percent year to date.
Here is a graph of growth / value relative performance for the two pairs of indices (data from Bloomberg):
Value and Europe have outperformed growth and the US for more than a decade, and strategists have been keeping up with catch-up transactions for almost as long. And now both are catching up at the same time, and fast. Maybe this is proof that a lasting factor or style rotation is finally taking place?
Lamont quickly points out that three weeks is too short a time to declare a lasting trend. But he gives two thoughts on what might be behind this trendlet.
First, the European value index was weighted heavier for finance and energy (25 percent and 7 percent of the index, respectively) than the US one (20 percent and 5 percent). This means more benefit from recent rate hikes and the recovery in oil prices.
Subsequently, the valuation gap between value and growth grew in both regions, but in Europe the gap became extreme. The forward price / earnings ratio of the growth index at the end of last year was around 11, compared to 27 for growth. The 16-point gap widened from 10 points before the pandemic. Lamont says:
In terms of valuations, the tremendously better performance of growth against value in Europe in recent years is not necessarily justified by changes in the company’s fundamentals such as earnings. This pushed the valuation differential to extreme levels. It can just be simple that the rack can stretch just that far before it cuts back.
There may also be a more common point to make. During the pandemic, there were more restrictions and less fiscal stimulus in Europe than in the US. As a result, its economies have recovered less strongly. Perhaps what we are seeing are investors who expect that when the pandemic subsides, Europe could have a nice cyclical bounce, already prevalent in the US, that will help European value stocks. A trade to watch in 2022.
Bank shares find a new way to disappoint
U.S. bank shares have risen 10 percent over the past month, despite enduring some difficult days recently, and the S&P has outperformed solidly over the past year. They have also mostly risen on fundamentals: the valuation of the KBW bank index, at about 11 times forward earnings, is right in line with the levels of the past few years.
Bank profits are generally considered to be sensitive to the slope of the yield curve, on the grounds that they finance themselves short-term and long-term lending. In fact, they are even more sensitive to short-term rates, which are rising rapidly. Furthermore, credit card lending volumes continue their return, and business loans are finally joining. Fed data:
In short, it is tempting to bet that bank shares will keep the momentum going. But while the big banks that reported this week – such as JPMorgan, Bank of America and Citigroup – showed strong revenue trends, the story was higher spending. JPMorgan led the way. Of the FT:
“We’re in for a few years of sub-target returns,” JPMorgan chief financial officer Jeremy Barnum said in a call with analysts. Barnum said the bank would benefit from higher interest rates and greater demand for loans, but this would be offset by a decrease in investment bank fees and more spending on new investments and payments.
The bank plans to spend an additional $ 3.5 billion on technology, rental, marketing and acquisitions to face emerging fintech and non-banking competitors.
“It is a lot of competition and we aim to win. “Sometimes it means you have to spend a few bucks,” said Jamie Dimon, JPMorgan’s CEO.
Goldman Sachs CEO warned against “wage inflation everywhere” after a big jump in spending hit the Wall Street bank’s fourth-quarter profit.
David Solomon said in an interview with the Financial Times that Goldman, like other large companies, is facing higher wage demands from its employees. “There is no doubt that inflationary pressures around compensation have had an impact,” he added.
Things are finally going the banks’ way, but it seems, at least at the largest, investors are not going to see the money. In lending businesses, the money goes to technology; in investment banking, to the bankers. Brian Foran, an analyst at Autonomous Research, sadly remarked: “Somewhere there is a report with my name on it that says banks’ investments in technology can lead to sub-50 efficiency ratios. [non-interest expenses as a proportion of revenues] long-term. So far, we have not even figured out how to break 60. ”
It will be interesting to see if the smaller regional banks, which report in the next few weeks, follow the same pattern.
Insurance and fires
It was good to see this article in The Wall Street Journal, about two of the largest U.S. insurers, AIG and Chubb, pulling out of large parts of the California home insurance market because they view the risk of wildfire as uninsured. There are a complex set of issues here, but the key point is this: insurance prices send important messages about the dangers of climate change, and government regulation and subsidies in fire and flood insurance often stifle those messages:
Some insurers are frustrated that California regulators require them to set home insurance rates based on their historical loss experience, not projections of future losses determined by disaster modeling. Such models may reflect detailed, location-specific data that insurers feel they need amid increasing wildfire activities that are partly linked to climate change.
I wrote about how climate change has served historical modeling, necessitating disaster modeling, in the case of floods. The same goes for wildfires. But even if regulations change, some things will still become impossible to ensure profitably due to climate change. Chubb and AIG provide a dose of reality we need that demonstrates the real social benefit of finance. Expensive homes in California that become uninsured will send a much stronger message than another bank’s glamorous ESG campaign. No one should run the risk of losing everything in a fire. But at some point, facts have to be faced.
A good read
A Blackstone-backed landlord who promises a free purchase option on your dream home – what could go wrong? The FT’s Mark Vandevelde dig deep on the rent-to-buy industry.