The Global Financial Crisis Ended Years Ago. But Why Are European Banks Still Suffering.

Posted by David Hunkar on 10 February 2016, 3:21 am

European banks have under-performed their U.S. peers for many years now. Though the Global Financial Crisis ended many years ago, European banks are still stuck in mud. After the financial crisis, banks in the continent muddled through the sovereign debt crises including the multiple episodes of the Greek saga. Last year it appeared like they finally stabilized and were finally catching the escape velocity to head into the orbit. But that rosy scenario failed to materialize and now they are staring down again at the bottom of the abyss.

With just one month over, European banking stocks are already down heavily so far this year. The benchmark STOXX® Europe 600 Banks Index is down a shocking 25% as shown in the chart below:

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Source: STOXX

According to John Stepek of MoneyWeek European banks are not very good in making money. I agree with this assessment. John further wrote:

The trouble with the banking sector

You see, European banks have been in trouble for a long time, and the process of cleaning up their balance sheets is far less advanced than in the US or even the UK, as James Ferguson of MacroStrategy Partnership regularly points out.

None of this is particularly new. As The Wall Street Journal puts it: “Banks don’t face an acute crisis as in 2008. It is something that in some ways looks worse: a chronic profitability crisis that makes it impossible for banks to build up barely-adequate capital bases.”

So your basic problem here is that the banks still need to do a lot of restructuring work. But if they are doing it against a backdrop of minuscule rate spreads and a potential recession – well, that’s going to take its toll.

And if they can’t keep topping up their capital via profits, then they might end up needing to stop paying dividends, or coupons on junior debt, or they might need to issue equity. Or, as the Wall Street Journal notes, they might have to “make riskier loans that pay more but have a higher chance of default”.

Hence the fear. Sure, it’s hard to see a bank going bust in a world where central banks have already made it clear that they will keep banks liquid. Whether you’ll make any money by investing in the things is quite another matter. And the last thing the world needs is the monetary transmission mechanism being gummed up again into the bargain.

Source: The biggest problem for banks: they aren’t very good at making money by John Stepek, MoneyWeek, Feb 9, 2016

Here are a few comments on European banks:

In addition to not being good at making money, most European banks are run by incompetent leaders and boards. For example, banks were very reluctant to raise capital by issuing new shares after the financial crisis.
Unlike the U.S., regulatory and policy makers in Europe dither over every single issue. So on top of inept management investors are forced to deal with moronic policymakers and regulators who move at the speed at sloths. For example, the UK is a classic example of this case. The British government, which usually acts like its a nanny, still owns stakes in Royal Bank of Scotland(RBS), years after bailout out the failed bank. Ironically the bank’s name still includes the word “Royal”.
Banks were slow to slash costs compared to their US peers. Keeping open thousands of unprofitable branches to thousands of excess employees make the banks perennially inefficient and noncompetitive. UK-based Barclays(BCS) is one such example.

From an investment standpoint, select European lenders are worth looking at current levels. My classification of these banks:

The Good: ING Groep NV (ING), Nordea Bank AB (NRBAY), Swedbank AB (SWDBY), Danske Bank (DNKEY), Svenska Handelsbanken AB (SVNLY), UBS AG (UBS)

The Bad: Banco Santander SA (SAN), Banco Bilbao Vizcaya Argentaria S.A (BBVA) , Erste Group Bank AG (EBKDY)

The Ugly: Deutsche Bank AG (DB), Commerzbank AG (CRZBY), The Royal Bank of Scotland Group plc (RBS), Barclays PLC (BCS), Societe Generale (SCGLY), Lloyds Banking Group PLC (LYG)

Disclosure: Long SAN, BBVA, ING, EBKDY, SWDBY, SCGLY

The Correlation Between Stock Markets And Oil Prices Remains High

Posted by David Hunkar on 9 February 2016, 3:21 am

Brent crude oil prices closed at just over $33.00 today. Since late last year the price of oil and equity prices are moving in sync with each other. The correlation between oil prices and stocks jumped to high levels in January according to an article by James Tierney, Jr. of Alliance Bersntein. From the article:

Equity markets and oil prices are behaving lately as if they’re glued together. Our analysis suggests that the correlation is unjustified and investors should start thinking about what might happen when they become unstuck.

Recent concerns about the global economy are reasonable. Investors are digesting a complex array of macroeconomic challenges, from China’s slowdown to the Fed’s monetary policy direction. However, it feels like the oil price is dominating market sentiment. In January, return correlations between US stock prices and oil were almost twice the ten-year average (Display).

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Source: Will Oil Prices and Equities Stay Hitched?, Context, AB blog

Though oil price movements affect the global economy and equity markets to some level, the scale of current lockstep movements between oil and stock prices is surprising. Oil is just one of the many commodities that are traded on a daily basis globally. But in the past few weeks, equities have declined as though oil is the only factor that matters.

Taking a different angle on energy sector and share prices, Brad Sorensen of Charles Schwab wrote in a report that investors who are underweight in energy sector may want to add to their portfolios. From the report:

Going forward, we are likely to see more bankruptcies in the energy space, which will take some supply off the market. Investment in Canada’s oil and gas industry is expected to be 13% less in 2016 compared with 2015.³ While the reduced sanctions on Iran will put more oil onto the market, there are still major infrastructure issues in Iran that will limit the amount of oil it can pump. Rumors that OPEC could limit production also exist. Also, Iraq’s oil minister recently stated he was seeing more flexibility from Russia and Saudi Arabia with regard to potential production cuts.⁴ And in fact, Russian President Vladimir Putin has said Russia’s 2016 budget was calculated with an assumed $50/barrel oil price.⁵

So what does all this mean for investors? To us, it means that investors who are underweight to the energy sector should start to add to positions to bring their portfolios up to market weight. Interestingly enough, the weight of the energy sector within the S&P 500^® Index has fallen to near its lowest level in at least the past 40 years. This leads us to believe there may not be more downside to go, and an oil price reversion could mean upside potential for those investors who are patient.

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Notes:

³ Source: The Financial Times, “Investment in Canadian oil and gas to be further slashed,” 1/25/2016.
4 Source: Bloomberg Business, “Saudis, Russia seen by Iraq as more flexible on oil-output cuts,” 1/26/2016.
5 Source: BBC News, “Russian economy hit by oil price slide,” 1/25/2016.

Source: Schwab Sector Views: Cutting Through the Energy Noise, Charles Schwab

It is not just the oil sector that investors should be looking at due to the current volatility in the markets. Opportunities also exist in other sectors such as banking, chemicals, oil equipment and service providers and transportation. For instance, lower oil prices are bound to benefit many but not all chemical firms since oil and petroleum products are one of the key ingredients in the manufacture of chemicals.

Long-Term Investors Can Consider Adding North American Railroad Stocks

Posted by David Hunkar on 8 February 2016, 3:33 am

North America railroad stocks have declined substantially in the past year. As the volume of coal and oil shipped by rail continues to fall, railroads are adversely impacted. When crude oil was trading over at $100 per barrel, “oil by rail” was projected to be a huge opportunity for railroads when producers especially share oil producers shipped increasing amounts of oil by trains rather than by pipelines. However the plunge in oil prices has dampened the talk of the oil by rail story.Coal is another commodity that is hurting railroads. With lower oil prices and also lower natural gas prices, coal shipments have also declined.

Long-term investors with a time horizon of at least five years can consider adding railroad stocks to their portfolios in a phased manner. Currently railroads are trading at attractive levels compared to a year ago.

There are many advantages of owning railroad stocks. One of the main advantage is that the North American railroad industry is an oligopoly and only a handful of Class I railroads dominate the entire continent. The following is a pictorial representation of the oligopoly nature of the US railroads:

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Source: Bulk Commodities and the Rails: Still Crazy after all these years, Dr. Mark Cooper, Consumer Federation of America

Oil and coal are just two of the many products that railroads transport across the continent. Many other commodities are best suited for transportation by railroads only as opposed to trucks or planes. For example, bulk products such as agricultural commodities are easier and cost-effective to ship by rail than trucks.

The five Class I US railroads are listed below with their current dividend yields:

1.BNSF Railway – Private. Owned by Warren Buffet’s Berkshire Hathaway.

2. CSX Transportation (CSX)
Current Dividend Yield: 3.15%

3. Norfolk Southern Railway (NSC)
Current Dividend Yield: 3.36%

4. Kansas City Southern Railway (KSU)
Current Dividend Yield: 1.74%

5. Union Pacific Railroad (UNP)
Current Dividend Yield: 2.93%

The two Class I Canadian railroads are listed below with their current dividend yields:

1.Company: Canadian National Railway Co (CNI)
Current Dividend Yield: 1.68%

2.Company: Canadian Pacific Railway Ltd(CP)
Current Dividend Yield: 0.84%

Note: Dividend yields noted above are as of Feb 5, 2016. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Kansas City Southern operates in the central states and Mexico. Canadian National is the best run North American road and is a dividend grower. Recently the firm increased the quarterly dividend payments by 20%.

Similar to the US, Canada is dominated by just two railroads noted above. The huge country is split into two parts among the railroads with the western part covered by CP and the eastern part by CN.

Though railroad stocks have under-performed the market this year and may be volatile in the short-term, investors picking them up at current levels should earn a high total return provided they hold them for five years or even more.

Disclosure: Long CNI, CSX, NSC and UNP