Deutsche Bank: TBTF Edition

Over this past summer, I had the pleasure of reading Andrew Ross Sorkin's book 'Too Big To Fail', a beautiful reconstruction of the financial crisis at its roots. The book claims to have been based off of many interviews & previously-secret pieces of knowledge, and the material inside confirms it; it really is a fascinating book about the crisis.
The other day, I received in the mail another book titled 'Too Big To Fail', this one penned by Gary Stern and Ron Feldman, published in 2004. This book was essentially the 'warning shot' for the 2008 financial crisis, as it spoke of the dangers of bank bailouts. I have yet to dive into the book, but I'm very eager to do so. Aside from all the literature, while we thought the era of TBTF was more-or-less over, if not heavily reduced, Deutsche Bank this week proved that this is not the case.

Yahoo Finance

Attached from Yahoo Finance is a chart of Deutsche Bank's stock price from somewhere early in the trading session Tuesday, to the end of the trading session Friday. The Dow Jones Industrial Average is superimposed in green. You don't have to have a paid subscription to fancy charts and graphs to tell that DB was under some intense pressure both Thursday and Friday.

Thursday was not a good day for the banking sector. Two prominent events contributed to this general malaise, the first stemming from Commerzbank and the second from Deutsche Bank. Commerzbank announced that it would be eliminating nearly 10,000 jobs and suspending dividends for its stock on Thursday, news that sent a chill throughout the financial markets. This news came about prior to the start of the trading day, if my phone alerts are to be believed, and more or less set the tone for the financial sector before the American trading had even begun.

Trading kicked off for Deutsche Bank on Thursday pretty stationary from where it had closed Wednesday, hovering right around $12.25 per share. However, at around 12:20 PM ET Thursday, word got out that a handful of hedge funds were either pondering, or already commencing a cut in exposure to Deutsche Bank. This, of course, is not what investors wanted to hear, after the news about Commerzbank was already promoting a little more Advil than normal on this trading day. In a span of 40 minutes, from 12:20 PM to 1:00 PM ET, Deutsche Bank's stock plummeted from $12.22 per share to $11.39 per share, a 5.37% drop. The Dow responded similarly, dropping from 18,315 points to 18,151 points in that same timeframe. It eventually scraped the 18,100 mark right before 2 PM, but bounced back to close down over a hundred points on the day.

There are a lot of editorials out there with far more knowledge and experience than I possess, and that's fine; ideal, actually, as it gives people like me an opportunity to keep learning. And something that's been made a point of in some of these articles is that Deutsche Bank may remain Too Big To Fail. The financial markets certainly believe that; the CBOE'S VIX index jumped over two points in that same 40-minute time span we looked at above.

The nice thing here, though, is that this isn't Lehman Brothers 2.0. You'll notice that DB is sitting on a large quantity of cash reserves, has bonds that can be converted into equity if needed, and after Lehman in 2008, as well as observing the current state of our global economy, it would be nonsense to even imply that a bank as significant as Deutsche Bank would be allowed to fail. Deutsche is not Lehman 2.0, and is far from it.

StockCharts.com

After Thursday's scare, Friday brought a heavy dose of optimism back to the overall market, and especially Deutsche Bank. Its stock ended the day just over $13, a jump of over 10% compared to its Thursday closing price. This jump came on the heels of reports that the US government's settlement with the bank may come in around $4-6 billion, a fraction of the ~$14 billion charge initially levied against Deutsche Bank. I'm practically hitting my head on the wall at how I didn't realize that the settlement would be lower than the initial charge, leading to a rally like this; the bears got trapped and the bulls are running free in Deutsche Bank's stock, for now.

Technical indicators like the MACD and Bollinger Bands as portrayed above indicate that another, certainly more modest drop could be in the cards over the next couple days until the MACD crosses above the signal line again. What might be a bit alarming is how even despite Deutsche Bank's stock hitting an all-time low Thursday, it still stayed within the Bollinger Bands, which delineate the +2 and -2 standard deviations. Friday's rally has brought the price back just below the middle of these Bollinger Bands, but when you put together the still-iffy MACD and now-very-wide Bollinger Bands, a non-zero chance for further selling remains. I don't see it anywhere as severe as Thursday's selloff, but similar to the gradual downward trend we've seen since about May, depicted in the chart above.


Deutsche Bank is a Too Big To Fail bank, but it's a strong TBTF bank compared to the position Lehman Brothers was in when they started taking big beatings from hedge funds cutting exposure. Even if, for whatever reason, DB ended up needing government assistance to survive, common sense all but guarantees the bank would not go under, unless the end goal here was another significant shock to the system, and we know no one wants that.

Andrew

Trust and the Banking Sector

In my current semester, I have two communications-based classes. The other day, in one of these classes, the professor had us form a circle and take a few minutes to define exactly what trust is, and how trust can be gained or lost. There is no correct definition of trust, of course, as everyone interprets it differently. You may only trust someone after they lay down their life for you, or you may trust them as soon as you first shake hands.

Recounting that class period now, I can't help but think how ravaged the trust between investors and the banking sector has become, but also how ravaged the trust between big banks and the government has become.

Take, for instance, J.P. Morgan Chase (JPM).

Barchart.com

Over the last six months or so, JPM has been through its fair share of ridges and valleys. Perhaps the most pronounced of these oscillations was the Brexit-induced volatility in late June, when the value of J.P. Morgan's stock dropped to just over $57 in intraday trading. Today, we're back up to $67.49 a share as of Friday's close, over three dollars higher than the close immediately prior to the Brexit referendum.

Overall, this chart looks pretty okay to me, and the stats on paper concur. JPM is up nearly 13% in the last six months, and its price-to-earnings ratio is at a comfortable 12.07.
Technical analysis indicators aren't as warm to the idea of placing a Buy sticker on JPM, with the stock's Relative Strength Index at ~70 at Friday's close, right into Overbought territory. Bollinger Bands show JPM grinding along the top band in the last few days, even closing above the upper band three of the last five trading days. It's not insensitive to believe a correction is coming.

But, this is where things get tricky. J.P Morgan's stock could very plausibly stick around these higher levels. We could see repeated intraday breaches of that upper Bollinger Band down the road, and the RSI could easily inch higher. This is the land of broken trust between investors and big banks, big banks and the government, and the government and the investors.

This handy chart I drew up at 3:40 in the morning illustrates how the lack of trust between the three sectors is leading the banking sector to moves irrational moves.

The government, as well as the Federal Reserve, clearly has a problem with investors these days. Time and time again we've heard Fed chairwoman Yellen and other high-ranking officials comment on how the financial markets seem too complacent, purportedly setting the foundation for a benchmark interest rate hike later on in the year. This happened once before, in June, but rate hike chances were eliminated when the United Kingdom voted to leave the EU. Now it's September, and last month at Jackson Hole, Yellen again began painting some more hawkish tones onto her speech, with a handful of other Fed people being more direct and clearly indicating they are ready to raise the benchmark interest rate.
This was all fine and dandy until the ISM Manufacturing PMI number came out this past Thursday. Expectations were for a value somewhere around 52, so there was some egg on some face when the value was released as a 49.4, the lowest in seven months and now into Contraction territory. Almost immediately, the air became thick with the concern that this would be another case of the Fed building up the case for, but not actually being able to hike interest rates. However, calm prevailed until the August jobs report this past Friday, which missed by 29,000 (180k expected, 151k actual) and held the unemployment rate steady at 4.9%. Surprisingly, though, the three benchmark US equities indexes all ended in the black that day. Why? Who knows. All we know is that we're going back around the circle we were in back in June, but this time investors don't seem to be listening all too hard. Equities remain near 52-week, as well as all-time highs, something that will be interpreted by the Fed as complacency but what is really a lack of trust.

Investors aren't too keen on investing in the banking sector. If you managed to figure out the round-about that the Fed has been going around re: hiking interest rates since this past June, congratulations, you can appreciate why there's a general hesitancy to firmly invest in the banking sector.
Profits remain low across the board due to historically-low interest rates, and big-name banks like Deutsche Bank are cutting jobs to compensate for the fall in profits. This has led many banks' shares lower; our JPM example again plays in here, with the bank's share value up a measly 2.21% year-to-date.
For many investors, this is a solid buy sign. The economic recovery continues slowly chugging along, and the overall banking sector is valued pretty okay compared to pretty-overbought defensives. But we aren't seeing a massive rush to the banking sector, and the blame for that is placed squarely on the Fed for inconsistent messages (not solely to their fault), breaking the chain of trust between investors and banks in financial markets.

It's pretty accurate to say that the banking sector doesn't exactly look at the government and Fed with a wink and a smile. The inconsistent Fed messaging has poisoned the trust link here, too, with banks not entirely sure which directions to take internally as the Fed scrambles to find its direction. There's little help coming from hesitant investors, and the government doesn't appear to be about to lay down an Abe-level fiscal stimulus package, leaving it up to the Fed to stimulate the economy and make banks highly-valued again. Of course, the Fed isn't currently doing this, so the banking sector is more or less dead in the water until either investors start wading back into the waters again, or the Fed finally hikes rates like it says it will. Until the latter happens, however, you'll be hard-pressed to find a willingness to trust.



I almost invested in a bank ETF the other day. I started remembering the hawkish Fed speak, anticipated the Manufacturing PMI would be positive, and there weren't any signs to be remarkably pessimistic on non-farm payrolls. Fast-forward to today and we're in another world of uncertainty, albeit not as uncertain as we were immediately post-Brexit (i.e. the yen isn't in the double-digits again). I didn't invest in that ETF, and do not plan to before the FOMC's September meeting, because I have a low amount of trust that the Fed will be able to confidently carry through with their not-so-subtle indications of an impending benchmark rate increase. I also have a low amount of trust in that any rate hike would really help banks- the most recent economic data from last week likely bars any interest rate increases from the current level beyond 50 bps until 2017, and in order for banking sector profits to swell, we'll need more than that.

Trust is hard to gain but easy to lose, and we've got a lot of trust to gain back.

Andrew