Unhedged Newsletter: Markets React to Bank Earnings
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Good morning.
Markets did not mind the $132bn in hold-to-maturity losses Bank of America reported yesterday (and rightly so). But they were unimpressed by the bank’s 10 per cent increase in profits, eclipsed by Wells Fargo (68 per cent) and JPMorgan (38 per cent) last week. Does the order in which similar companies report affect how stocks react to earnings? If you know, enlighten us: [email protected] and [email protected].
Growth is strong, in case you needed a reminder
There was a moment, about a week ago, when one could say “the Fed is done” with all the confidence of a pundit with the data behind him and the market two steps ahead. One could even speculate, breezily, about a Fed pivot towards cutting, and a peak in long-term interest rates. Stocks were weak, the labour market was loosening a bit, war was threatening to increase oil prices, Fed officials were making dovish speeches. Bond yields, long and short term, were rolling off their highs.
Then a warmish inflation report landed last Thursday, followed by healthy reports from the big banks. The final nail in the coffin of the peak rates story was yesterday’s retail sales report for September. It showed that retail sales rose 0.7 per cent from the month before, well ahead of expectations. The release raised the consumption component of the Atlanta Fed’s third-quarter real GDP growth estimate by 25bp, to 2.8 per cent. Spending is not slowing down and neither is the US economy.
Both 30-year and two-year bond yields are back to their multi-decade highs, along with everything in between. The chances of another rate increase by the end of the year, at 25 per cent a week ago, are now near 40 per cent. The certainty investors want most of all — certainty about where we are in the rate cycle — remains elusive.
The retail report underscores one complexity of this cycle: the unstable balance of goods and services spending. As we noted last month, the goods-back-towards-services rebalancing may well be over. Goldman Sachs economists argue in a note out on Monday that this may be due to the enduring impact of remote work. Services you buy while working in the office, like tailoring and taxis, have been substituted for goods you buy while working at home, like electronics. Yet in the bowels of the retail sales data, some of the biggest September changes were in categories caught up in this macro change, such as electronics and clothing stores. How to tell apart cyclical and secular changes in spending?
The strong retail report also goes a ways towards eliminating one suspect in a mystery that has received attention both here and elsewhere: who killed consumer staples stocks. The idea that stressed consumers — facing dwindling pandemic savings and higher debt costs — are trading down when shopping for food and other basics now appears unlikely to be the culprit. It seems more likely that higher real rates have reshaped investors’ portfolio preferences, eliminating some of the premium paid for safe stocks. Similarly, the marginal but noticeable decline in card spending, which we discussed last week, looks more and more like a false signal of a consumer slowdown.
Japan’s exchanges will name you and shame you
Imagine a programme on CNBC dedicated to making fun of companies whose returns on equity have slipped. For one hour a month, a disappointed Carl Quintanilla tells viewers about the companies that have made that month’s Nasdaq Naughty List. Corporate Dunce of the Month presented by iShares goes to the CEO who has lost the most shareholder value.
Something like that, with a bit less spectacle, is going on in Japan. From the Financial Times over the weekend: Japan’s stock exchange is to introduce a radical new name and shame regime to drive better governance and higher valuations. The Japan Exchange Group, which controls the Tokyo and Osaka exchanges, told companies in March that it wanted to see progress towards lifting corporate value. Hiromi Yamaji, chief executive of JPX, now says he intends to go further in making it clearer to investors which companies are meeting those goals, by for the first time publicly naming the listed companies that have complied with his requests. Yamaji highlighted earlier this year that roughly half of companies listed in the prime index have a price-to-book ratio of less than one. Now the exchange intends to track companies that have disclosed plans to comply with the guidelines, in effect shaming the non-compliant.
Remember the set-up. After the asset bubble burst 30 years ago, balance sheet conservatism swept across corporate Japan. Hallmarks of the post-1990s bloat include cash hoards, empire building and cross-company shareholdings. For a decade, Japanese authorities have nudged companies towards a more shareholder-friendly stance, with limited results. But more recently, a reform push led by the Tokyo Stock Exchange has yielded more. The TSE’s crucial tool has been a restructuring of its listing criteria. Now, to be in the top “prime” listing tier, companies must meet certain standards (eg, minimum market cap) and publish plans to rise above the 1 price/book threshold.
When the TSE laid out these plans earlier in the year, Japan watchers we spoke to thought of “prime” listing as a carrot for companies. A more selective listing tier would pave the way for more attractive index products for investors, giving prime companies better access to capital. However, as we wrote back in March, “The new rules are vague and full of wriggle room, designed more to encourage capital discipline than force it.” With only a carrot, some wondered if companies would feel proper pressure to comply.
With its name and shame campaign, the TSE is bringing the stick. The reason why is clear. Fewer than one-third of prime-tier Japanese companies have followed the new TSE guidelines, notes Bruce Kirk of Goldman Sachs. Those that have complied tend to be the weakest companies, with p/b ratios below 0.5; many stronger companies apparently feel like they can get away with it. “For corporates who want to ensure that they are on the TSE’s first list when it is published early next year, the clock is now ticking,” Kirk wrote in a recent note to clients.
Will it work? The US may not have a corporate dunce of the month award, but what we do have is an army of sellside researchers watching nearly every listed stock on behalf of investors. Not so in Japan. A dearth of sellside coverage may mean companies can fly under the radar, despite the TSE’s complaints. This isn’t the first time Japanese market authorities have tried to induce behavioural change via name and shame. Old-timers might recall the JPX 400 index, better known as Japan’s “shame index,” created in 2014 to shove all the best Japanese companies into one ticker, based on objective criteria like ROE. As the FT’s Leo Lewis wrote, the JPX 400 would “promote corporate value creation, efficient capital use and governance improvements. Its constituents would be heroes; its trackers would be richly rewarded; its rejects would cringe in shame.” The JPX 400 was subject to front-running and was saddled with embarrassments, such as the inclusion of the company behind the Fukushima nuclear disaster. But some evidence suggests the JPX 400 was ultimately successful. One academic estimate found that the index’s incentive structure lifted total Japanese market cap by something like 7 per cent.
One could paint a picture of revolution by a thousand reforms. Alongside JPX’s pressure, activist investors keep piling in. The amount of cross-shareholdings is the lowest on record since data began in 2009. Next year’s revamped Nisa investment accounts, letting individual investors buy $24,000 in stocks a year tax-free, could attract inflows from Japanese households, who are sparsely allocated to equities. But after a 20 per cent rally this year through June, the Topix has traded flat. Investors appear to have priced in as much good news as they can stomach. (Ethan Wu)
One good read
Ben Bernanke interviews the FT’s Chris Giles.
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