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Weekly Investment Idea – JPM
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By the end of last week, the Dow Jones Industrial Average (DJIA) pulled back into the daily 50 EMA for the 3rd time in 5 trading days. Once again, the tech stocks came to the rescue with dip buyers buying the dynamic support levels. 64% of the companies in the DJIA are trading above their daily 200 EMA which is up from 37% at the end of 2021, so overall the index is likely to continue moving higher, just maybe at a slower pace.
On Friday the heavy selling within the DJIA came from the finance cohort, with JP Morgan & Chase (JPM) declining -6.15% following their earnings report. We’re now into the US earnings season and although JPM reported a better-than-expected EPS of $3.74 their CFO warned of continued financial headwinds as Q4 2021 revenue missed expectations by $520mln. Q4 profits fell 14% year-on-year but overall profits for 2021 were at record levels. Higher expenses will be a worry going forward for the company and industry alike but profits equal earnings minus expenses, so if the banks can earn more, this sell-off could be an overreaction to what was a headline designed to temper forward expectations.
Banks expand their balance sheet
The ongoing coronavirus pandemic poses a serious concern that many affected businesses will be unable to pay their outstanding bank loans and at the same time, some will need additional loans to tide them over until normal levels of economic activity return. Banks likely will want to offer their customers help during the downturn, but some might hesitate or be incapable of extending a large volume of new loans, especially when the prospect of a recession looms.
The Fed’s quarterly survey of Senior Loan Officer Opinions on Banking Practices is a reliable indicator of banks’ willingness to make loans. A study found that bank lending slowed after a rise in the percentage of banks tightening lending standards. The chart shows the compound annual rate of change in commercial and industrial loans alongside the net percentage of banks tightening standards for lending to large and middle-market firms.
The drop in net percentage of banks tightening standards would appear to have bottomed in the middle of 2021 and then eased towards the end of 2021. We have to wait for the next Senior Loan Officer report to confirm this though.
The principal business of the banks is to make loans and the rising Commercial and Industrial loans through the latter stages of 2021 into 2022 is a good sign.
US businesses are likely to have tapped credit from the banks to buy up inventory that had been scarce due to supply chain issues. If this is the case the increase in loans suggests that the banks are feeling more confident that businesses will be able to sell the inventory, that demand is still rising, and that the loans will be paid back. This is basically economic and monetary expansion. If the Fed then start to raise rates the question is, can the Commercial and Industrial loans repayments be met? Is the economy sufficiently robust?
Banks AFS go negative
Banks hold Available-For-Sale securities (AFS) which amount to debt or equity purchased with the intent of selling before they reach maturity.
One measure seen with rising yields is that as the yield of a bond increases the nominal value of a bond or equivalent, depreciates. The banks are holding a lot of US Treasuries and MBS and the graph above shows that these nominal holdings have gone into the negative for the first time is a few years. The banks must hold this Tier-1 collateral as part of their leverage requirements, the only alternative would be to raise cash, a lot of cash.
The fact that a larger number of banks are now holding AFS which is negative, will reflect in their Other Comprehensive Income filings and ultimately be a potential drag on earnings. We could be hearing of debt being written off etc.
Forward guidance
According to Jamie Dimon, CEO of JPMorgan Chase, the US economy will grow strongly in the months ahead due to strong consumer spending. Despite acknowledging that some Americans face challenging economic conditions, Dimon insisted that the underlying economy is strong, and that the consumer balance sheet is in the best shape it has ever been. Spending today is 25% higher than it was before COVID. Dimon told CNBC: “They have $2 trillion in their checking accounts.” The debt-service ratio is the best in 50 years. The rising prices of homes, stocks, jobs, and wages tell you what to expect in the future.”
This optimistic outlook from the head of JPM shows confidence in the US consumers and the commercial and industry’s ability to pay back loans and therefore for the banks to make more profits. Especially if they see the rates go up.
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JPM’s share price dropped back towards the $156 and daily 200 EMA. I am expecting both levels to get tested today before the bounce back. The bank has a flawless balance sheet with a solid track record and pays a dividend. Meaning, value investors will be interested around the 200 EMA. It is fair to say that JPM may not have performed as well as its banking peers, but a 13.9% annual return is not too shabby and on par with the US market.
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The prospect of loan growth, rising rates and economic expansion have pushed the XLF, financial ETF higher. While this ETF is above its daily 200-period EMA I would be looking for value entries on all the US banks.
The JPM share price is about 25% undervalued, so an upside target could be $211.50 assuming all else remains equal and we don’t have a catastrophic start to 2022 due to COVID. For the value investors getting a 2.53% dividend payment may be enough as it not only beats the industry standard but is also forecast to increase to 2.8% within the next 36 months.
