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Brexit, banks and opportunity

Brouwer & JanachowskiFebruary 26, 2016

Stocks eked out a small gain this week (as of pre-open Friday). We’re now up 6% from the market lows we saw two weeks ago. The S&P 500 has settled into a trading range of 1850-1950. The news flow was mixed. Saudi Arabia, Russia, Venezuela and a few others agreed to “freeze” oil at current production. Trouble is, “current” production is at an all time high. Iran refused to stand by any agreement and the Saudi Oil Minister casually remarked they are prepared to see oil at $20 bbl. Well, maybe. Here’s what else caught our attention.

  1. Banks, Banks: JP Morgan’s investor day on Tuesday highlighted the risk of lending to energy companies. The bank coolly announced they would add $500m to reserves to cover energy loan losses. Now, they have $44bn in energy related loans, assets of $2.4 trillion (around 13% of GDP) and $230bn in equity. Even so, other banks are less able to absorb such losses. Financials have underperformed the S&P 500 by round 6% this year. We feel they are complex businesses with latent liquidity risks. The market needs greater confidence in banks’ growth potential. And it’s not there yet.
  1. Earnings: at this point, 87% of companies have reported. Did companies with global exposure and energy underperform? Yes. Here are the earnings of the S&P 500 in Q4 2015:

S&P 500

S&P 500 ex Energy

S&P 500 ex- Energy

International focused

S&P 500 ex- Energy

U.S. focused

Earnings

-3.6%

+2.5%

-3.2%

+6.9%

Sales

-3.7%

0.5%

-7.4%

+3.9%

Source:  FactSet

You can see the progression. Take out, admittedly, two very important components of the market and we have a reasonable earnings period. This should underpin valuations for a while.

  1. Brexit: the British referendum to remain or stay in the UK comes in June. One prominent UK politician announced his support for leaving and sterling took a sharp hit.

via GIPHY

Here’s the chart:

Sterling has fallen around 13% over the last few months. And just as in September 2014, when the Scottish independence vote took place, markets are very skittish about what it means. Our view: on the day people will vote to remain. But until then, expect more volatility.

Bottom Line: Markets are gaining confidence. The Treasury market rallied again to end Thursday evening with the 10-Year at 1.70%. It's not a fear trade. Simply that demand is high and supply low. Expect more weeks of sideways markets.

Do please check out our interview with former Federal Reserve Governor Robert Heller.  He has unique and very interesting insights. And was a delight to meet.

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--Christian Thwaites, Brouwer & Janachowski, LLC

 

Please note that the discussion of the investments and investment strategy of Brouwer & Janachowski, LLC (“Advisor”) (including Advisor’s research and investment process) represent the investments and investment strategy of Advisor at the date of this commentary, and are subject to change without notice.  Advisor cannot assure that the type of investments mentioned in this commentary will outperform any other investment strategy in the future, nor can it guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. 

References to an individual security should not be construed as a recommendation to buy or sell that security.  In addition, the securities noted in this presentation are only several of the successful as well as unsuccessful investments by Advisor, and do not represent all of the securities Advisor has purchased, sold or recommended. 

Advisor cannot guarantee the accuracy or completeness of any statements or numerical data in this commentary.  Past performance is no indication of future results.