Recent events such as a Federal Open Market Committee (FOMC) policy meeting, a Bank of Japan (BOJ) policy gathering, an OPEC strategy session, end-of-the-quarter window dressing and a no-holds-barred U.S. presidential debate have not exhausted the list of reasons for stock and bond investors to remain vigilant.
New uncertainties are on the horizon, even though interest in risk-on equity exposure seemed to be rising. Despite increased volatility in the markets, my view at the start of October 2016 is that risk is somewhat overlooked, even though the S&P 500 added 0.2% last week.
|Index||Started Week on Sept. 26||Ended Week on Sept. 30||Change||% Change||YTD %|
Rate hike expectations increased last week after word that August Core PCE Prices dipped 0.1%, even though other inflation measures rose that month. An implied probability of a rate hike at the Fed’s December meeting climbed to 55.7% by the end of the last week, compared to the previous week’s 54.2%, based on the fed funds futures market. Plus, the 10-year Treasury Note’s yield closed last week unchanged at 1.61%, after dipping to 1.55% upon initial reports about problems at Deutsche Bank.
Futures Expiry: December 2016
Futures Price: 99.515
Open Interest: 99,733
|Target Rate (bps)||Current Probability %||Previous Day Probability %|
The Fly in the German Ointment
A retreat in the shares of German banking giant Deutsche Bank was spurred by renewed concerns about its capital position. German Chancellor Angela Merkel told reporters that the bank would not receive state aid if it faced a capital shortfall. The news understandably raised concerns something may be amiss at the bank.
The bank’s stock remains a market focus, after it endured a swoon on Thursday, Sept 29, following news some firms that clear trades with Deutsche Bank had reduced their positions and withdrawn some excess cash. Even though the bank’s stock fell that day by 6.7%, a turnaround ensued on Friday when bank CEO John Cryan sent a letter to employees that the bank was fine.
The stock rallied that day and gained further support after Agence France-Presse (AFP), the French press agency, reported that it was nearing a $5.40 billion settlement with the U.S. Justice Department, which announced previously it wanted $14 billion.
With Deutsche Bank declining to discuss details about current talks with the Department of Justice officials regarding resolution of the fine, any buying spree in the bank’s shares may turn into a new sell-off its stock. Of course, there were so-called “fixes” in 2008, as rumors sent Lehman Brothers’ stock soaring in the six weeks before its collapse.
Retail investors should avoid this bank stock, regardless of how “cheap” it looks. I see potential for a Lehman Brothers 2.0 sequel. If so, there is systemic risk to the European banking system that would require a bailout from the European Central Bank (ECB), if the German government refuses to help.
Negative interest rates only add to the bank’s problems, amid its high risk loan portfolio and extreme leverage with derivatives.
Germany’s national weekly newspaper Die Zeit reported that the German government and financial authorities are readying a potential bailout plan for the big bank. But that effort only would take shape if Deutsche Bank needed extra capital and failed to raise it in the open market. A worst case scenario would be for the government to take a stake in Deutsche Bank, as the U.S. government did when it helped General Motors (GM) restructure its debt.
Source: Bloomberg Credit 10-1-16
The value of Germany’s flagship bank more than halved this year after it posted its first full-year loss since 2008. The International Monetary Fund warned in June that the bank’s ties to the world’s largest lenders heightened its risk to the broader financial system. New headlines of elevated counterparty risk will give more downside fuel to the fire that will only unsettle markets worldwide.
A bailout of the bank probably is a question of when, not if. But it poses the problem of moral hazard to the ECB and other banking bodies. If the big bank is bailed out, every bank that has bungled its business will be seeking help, led by the Italians. But if Deutsche Bank nears a financial abyss, it will be saved because it is way too big to fail in the eyes of Europe’s central bankers. Once a bailout is announced, the markets should rally.
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Until next time,
Bryan Perry has spent more than 20 years working as a financial adviser for major Wall Street firms, including Bear Stearns, Paine Webber and Lehman Brothers. Bryan co-hosted weekly financial news shows on the Bloomberg affiliate radio network, and he’s frequently quoted by Forbes, Business Week and CBS’ MarketWatch. With three decades of experience inside Wall Street, Bryan has proved himself to be an asset to subscribers who are looking to receive a juicy check in the mail each month, quarter or year. Bryan’s experience has given him a unique approach to high-yield investing.