With the announcement of J.P. Morgan’s recent trading missteps comes another round of financial sector (and overall market) angst. For the past few years, investing in the financial sector has represented a stereotypical “risk on” trade. But now with JP Morgan’s announcement, everyone is taking a deep breath before returning into this segment of the market.
J.P. Morgan, as with most major financial institutions, will weather the long-term effects of its trading challenges well enough. The total losses may be higher than expected—more due to the market second-guessing J.P. Morgan’s positions than due to the misestimates on its part. Market observers may also note that traders with purely hedging duties rarely earn the sobriquet of being called “the whale.” However, the losses are not expected to amount to more than a few points off J.P. Morgan’s strong capital position. In the wake of the financial crisis, U.S. banks are very well capitalized.
Nevertheless, there will be an impact on the industry due to this untimely announcement. We can look forward to another round of regulatory intervention, and more political commentary on Wall Street versus Main Street after the U.S. election, depending on how results unfold. With the continued uncertainty in Europe and fears of a hard landing in China, this was not what the doctor ordered. It may be that we still need a quantum shift in the financial sector, but in the words of St. Augustine, “Lord, make me pure and holy, but not yet.”
However, tailwinds are building in the U.S. for a recovery on the asset side of our portfolios, which should be followed by some relief on liability valuations. Consider the following:
- U.S. GDP is building from an estimated 2.5% growth in 2012 to an estimated 3% growth in 2013;
- consumer confidence continues to rebound from the lows of 2009;
- U.S. non-farm payrolls and job openings are increasing just as unemployment initial claims turn sharply down; and
- personal consumption and commercial construction indexes are turning the corner.
So far, the U.S. recovery has been led by private fixed investments (non-residential) and exports. Previous recoveries have typically been led by residential fixed investment. If the U.S. housing market—supported by financial institution mortgage lending—continues its pace of recovery, there is a lot more upside still to come.
The U.S. housing market is indeed showing several signs of pulling out of its multi-year slump. New and existing home sales are retreating from their peak negative rate of change. The Case Shiller Home Price Index has stabilized, and home price affordability is nearing its long-term average again. With long-term (30-year) fixed mortgage rates at 3.7% and a significant backlog of potential buyers, buoyed by stronger job prospects, there is a lot of pent-up demand to fuel the market.
Many pension plan sponsors are still actively pursuing alternative investments, de-risking strategies or DB to DC plan conversions. But for patient investors, J.P. Morgan’s announcement is just another hiccup in the path that will soon be forgotten.