Review & Outlook

Our take on the investing, financial, & economic themes of the day

Predicting the Staying-Power of the Trump Rally

13 December, 2016 by Matthew O'Brien, Ph.D. in Commentary


Broken clocks have the virtue of being right twice a day.  What about broken stock market strategists?  They’re usually worse than broken clocks, because most of them change their predictions after they fail to materialize.  Thus I read today this snippet in the Wall Street Journal:

“We believe that the Trump rally will continue as long as the economy continues to reflate, and the market views higher inflation expectations and rates positively,” Jonathan Golub, the chief U.S. market strategist at RBC Capital Markets, wrote on Tuesday. The rally since election day looks like a “classic pro-cyclical, early-stage, reflationary market,” he said, with money flowing into financials, “deep” cyclicals, and small caps. Stocks that are more domestically focused are also benefiting, a bet on the expected new policies from the new administration. This is all something Golub expects will continue in 2017.

Indeed.  Here was Mr. Golub in the Journal just over a month ago on November 8th:

In this unusual election cycle, short-term moves could be flipped — and exacerbated. Jonathan Golub, an equities strategist at RBC Capital Markets, predicts the S&P will rally between 3% and 4% if Mrs Clinton wins, and fall between 10% and 12% if Mr. Trump takes the White House.

So much for that.  The way to get some market predictions right is to be a perma-bear or a perma-bull: if you always call for an impending rally, or always call for an impending crash, then at least sometimes you’ll predict the future correctly–just like the broken clock.  The better approach, of course, is to avoid making market calls at all, because there’s no way to make them reliably.  The banks and brokerages that employ market strategists are fundamentally sellers of financial products, and the best way to sell these products is to induce you to change what you’re doing now, usually by convincing you to extrapolate the current trend and chase the recently outperforming asset class.  Market strategists can provide useful data and provocative insights that can partially inform an asset allocation approach, but the business of calling the market is a fools errand.


Post-Election Reflections

10 November, 2016 by Mark O'Brien in Commentary

What If Trump wins which, we are told, is more likely than the polls would suggest?  The result could be a bit like the aftermath of the Brexit vote:  a sharp selloff, and then a rebound as investors rediscover that the president is part of a much larger system of overlapping and competing majorities, and that he alone is not all that powerful.  Speaking of federalism, the stock market prefers the president and Congress to be from different parties, which is, the polls say, what we will get.

The above is what I wrote clients in my most recent appraisal letter.  With these conclusions in mind, I dragged myself out of bed yesterday morning and got to the office thinking I would snap up some bargains at the open, which I expected to be down 1,000 points, maybe more. With computer at the ready, I sat and waited, and waited some more.  You know the rest: The stock market did not collapse.  Instead it went up at the open and continued to go up all day long.

The stocks that went up the most were ones without dividends or with very low dividends, and the stocks that went down in price tended to be the bond substitutes, companies like Verizon, which has a secure and attractive dividend.  Also up were healthcare and financial stocks, both sectors which have struggled under past regulations from the Obama administration and feared more regulations from a future Clinton administration.  Bonds also went down in price (by 10%), especially the bellwether 10-year Treasury bond, which everyone in the world follows.  Altogether, what happened today was exactly the opposite of what everyone expected would happen if Donald Trump managed to win, which no one expected. In sum the experts were wrong double over; they were wrong about the election and they were wrong about the aftermath of a Trump victory.

Why the bond sell-off and stock rise?  Now the experts are attributing it to impending infrastructure spending and deregulation from the Trump administration, which would encourage inflation and interest rate increases.

Today we’re back at work, another day.  But I am left with one thought.  How much of the mystery that we call the economy are we given to know?  In a career that has not been short, I have learned the same lesson over and over, no one knows the future, and it is a fool’s errand to try.

Why We Sold Wells Fargo

19 October, 2016 by Matthew O'Brien, Ph.D. in Commentary

Below is an excerpt from our sell report for Wells Fargo.  Many commentators have missed the real significance of the bank scandal, we think, which is about managerial negligence and a weak commitment to its fiduciary obligations to the shareholder owners of the bank.  Wells Fargo’s management imposed unreasonable sales targets on employees and then failed to grasp the consequence, which was the widespread opening of fake accounts, even as management pocketed “performance” compensation for (falsely) reaching cross-selling goals.     

On September 8 enforcement actions against Wells Fargo was were made public by the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau and the Los Angeles City Attorney, which collectively fined the bank $185m.  The government agencies alleged that Wells Fargo engaged in “widespread illegal activity” and said that employees had opened as many as two million checking, savings and credit card accounts without customers’ knowledge.

Shortly after the announcement of the fine, the US Justice Department announced that it was in the early stages of investigating Wells Fargo for criminal and/or civil violations in relation to the illegal account openings.

According to the CFPB, the fraud didn’t just amount merely to opening fake accounts, but “[b]ank employees temporarily funded newly-opened accounts by transferring funds from consumers’ existing accounts in order to obtain financial compensation for meeting sales targets ” [emphasis added].

The magnitude of Wells Fargo’s fine is a pittance compared to the bank’s $22bn in net profit last year; similarly the 5,300 employees already fired due to the illegal account openings is small relative to the bank’s 200,000 workforce.  The political and regulatory blowback from the scandal could be more serious, however.  Most worrisome for shareholders are the defects that the scandal reveals in Wells’ corporate culture, its internal controls, and future business strategy.  The illicit account openings and money transfers raise a general question about the security of Wells Fargo’s accounts and its compliance with money laundering and ‘know your customer’ rules, and an abandonment of aggressive cross-selling practices would leave Wells without its signature business strategy of the past fifteen years, without a visible alternative.

Longtime sell-side bank analyst Dick Bove points out that if Wells employees opened half a million fraudulent credit card accounts to meet sales targets, then what does this say about the loan officers’ credit underwriting standards—not to mention the accuracy of management’s grasp of its loan book’s quality?

The response of Wells’ senior management to the scandal has been largely evasive and unconvincing both in its account of the origins of the illegal cross-selling and its purported remedies (see, e.g., Lucy Kellaway, “Wells Fargo’s wagonload of insincere regrets,” Financial Times, Monday 19 September 2016).

In April of 2016 Wells’ longtime head of retail banking, Carrie Tolstedt, announced her retirement.  At this time Wells knew of the regulatory investigations into its cross-selling practices.  Nevertheless, Tolstedt was feted by the bank at her retirement and received substantial additional stock options as compensation.  In the press release announcing her retirement, Wells CEO John Stumpf stated, “A trusted colleague and dear friend, Carrie Tolstedt has been one of our most valuable Wells Fargo leaders, a standard-bearer of our culture, a champion for our customers, and a role model for responsible, principled and inclusive leadership,”

Tolstedt worked at the bank for 27 years and headed its retail division since 2008.  Fortune magazine reports that

Tolstedt was regularly praised for her unit’s ability to get customers to open numerous accounts. For a number of years, Wells Fargo’s proxy statement, which details executive pay, cited high “cross-selling ratios” as a reason that Tolstedt had earned her roughly $9 million in annual pay. For instance, in Wells Fargo’s 2015 proxy statement, the company said that its compensation committee had authorized Tolstedt’s $7.3 million stock and cash bonus that year, because “under her leadership, Community Banking achieved a number of strategic objectives, including continued strong cross-sell ratios, record deposit levels, and continued success of mobile banking initiatives” (Stephen Gandel, Fortune, “Wells Fargo Exec Who Headed Phony Accounts Unit Collected $125 Million” September 19, 2016).

Tolstedt’s performance compensation for achieving inflated and partially fraudulent cross-selling numbers suggests that senior management is better at running the bank to reward themselves, rather than the bank’s shareholder owners.

John Stumpf will testify before the US Senate this week in order to answer questions about the scandal; Stumpf already has refused to identify any senior executives who are responsible for the individual “bankers, managers and managers of managers” to whom the bank has attributed blame, and he refused to name the most senior employee let go thus far.

According to the Journal, Wells’ dedicated focus on cross-selling banking products to Mainstreet customers dates to the late 1980s when then-CEO Richard Kovacevich brought the strategy from the acquired bank Norwest Corp.  In 1999 the bank reported that its retail customers on average held three accounts and that it hoped to increase that number to eight.  This program was known internally to employees as the “Gr-eight” initiative; Kovacevich picked eight as a target because it rhymed with “great.”

Currently Wells reports that its average Mainstreet customer owns over 6 products from the bank.  Not only does this figure trounce the industry average, but Wells, unlike other banks, reports this figure explicitly in its quarterly earnings.

Some analysts have compared the Wells scandal to JP Morgan’s “London Whale trade,” which resulted in huge losses and fines over the bank’s failure to oversee its derivative trading risk, but ultimately proved navigable for Morgan.  But the Wells’ scandal seems more serious, because it cuts to the heart of Wells’ carefully crafted image as the plainspoken, ethical alternative to rapacious Wall Street banking.  At Morgan, by contrast, everyone knew that the bank had a big, aggressive, and lucrative tradition operation, which was one reason why you owned it.  If Wells’ corrects the incentives and culture that led to the problem, then it will presumably have to give up its marquee business strategy.

Regulators will now probably scrutinize all retail banks, whereas previously they had focused upon those banks with rarified trading and securitization practices that are far removed from the ordinary public’s everyday concerns.

Wells pays a handsome +3% dividend yield, which is safe and sustainable, due to its relatively low payout ratio of about 36%.  This fact alone will probably lead many shareholders to ignore the scandal and hold on to the stock, or even to buy its recent sell-off.

Nevertheless, on balance the uncertainty about Wells’ future retail strategy, risks of further regulatory and criminal action, and an apparently dysfunctional corporate culture coupled with managerial negligence makes selling more reasonable.

Twenty years from now, would you rather be paid in euros or pounds?

17 October, 2016 by Matthew O'Brien, Ph.D. in Commentary

I asked myself this question as I read the commentary about the recent sell-off in the pound sterling.  Here is the pound against the dollar:


Many commentators have taken the opportunity of the sell-off to castigate Brexit and Britain’s new prime minister, who seems bent on implementing the results of the referendum and not slowly walking it back.  Thus Martin Wolf, the leading economic mandarin at the Financial Timespronounced that the sell-off was the market’s verdict on Brexit’s foolishness.  Yet it seems much more foolish to me to divine in short-term currency fluctuations any judgements about sovereignty.  Let’s also remember that the Bank of England’s policy response to Brexit has been to weaken the pound, so it’s hard to argue that a weakening pound is itself somehow clearly attributable to Brexit alone.  In any case, if today you gave me an annuity that started paying twenty years from now — choosing either in pounds or euros — I wouldn’t hesitate in choosing pounds.  So too, presumably, would some of the founders of the euro.

Professed Sentiment vs. Deliberate Action: What Investors Say Often Isn’t What They Do

13 October, 2016 by Mark O'Brien in Commentary

In the mid-1980s I noticed that many portfolio managers, like myself, said they were bullish but were not managing their portfolios that way.  That’s because the previous ten years or so had been so bad that one just could not imagine they were really over.  Thus portfolio managers and other investors said one thing while doing another.  You can understand why. When I graduated from college in 1973, the Dow broke 1,000 for the first time.  Ten years later, the Dow was 740, and this did not include an adjustment for inflation, which was horrible in the period.

Now I notice that portfolio managers and other investors say they are bearish about stocks. In the often backwards and upside down world of stock investing, such bearish sentiment is often taken as a positive.  How’s that?  If investors are already negative, they cannot turn that way.  So, presto, bad is good. But are portfolio managers really acting out of bearish sentiment right now?  I’m not so sure. It could be the mirror image of the mid-1980s phenomenon. That’s because the last 25 or so years have been so good for stock investing that people don’t really believe they could be over.  Just in the last seven years stocks are up almost 200%.  Any paring back of stocks has been punished with bad stock performance.  The human inclination is to drag your feet and wait for more confirmation.

The lesson is to take sentiment indicators with a large grain of salt, because they may indicate what people are thinking and saying at the current time, but not what they are doing.