|By Matein Khalid| I had called for Brent crude to fall to $30 in successive columns since the November 2014 OPEC conclave in Vienna, when Saudi Arabia abandoned its traditional role as the “swing producer” the central bank of black gold. The world oil markets now face a supply shock, a demand shock, epic volatility and the loss of the “swing producer”. The world is running out of storage capacity, in Rotterdam, Antwerp, Galveston Texas, Kharg Island in Aberdeen. In 1999, this led to $10 Brent. The petro-currencies I track now price this macro scenario. Note the Canadian dollar has now fallen to 1.45 and some of my closest friends in Dubai/Abu Dhabi are in the market for an office tower in Toronto or Montreal. Brent and West Texas both traded at $29 on Friday. A century ago, John D. Rockefeller called the free fall in oil prices “the great sweating”.
The free fall in crude oil is catastrophic for the world’s oil producing provinces, from West Texas and North Dakota in the US to Russia, West Africa, Colombia and the Arabian Gulf states. The GCC economies have suffered a $500 billion deflation shock at a time when war, terror and revolution afflicts the wider Arab world. Since the GCC currencies are pegged to the US dollar, a deflation shock guts their domestic stock and property prices at the precise moment when the Yellen Fed has raised US dollar rates. It is no coincidence that Emaar peaked at 12 AED just after the Euro peaked at 1.40 in spring 2014. Now that Euro is 1.08 and Emaar is 4.5 AED, making a 50% implied volatility put sale irresistible even though Emaar options do not trade in the Chicago Board Options Exchange (CBOE).
The GCC faces a tough policy/macro milieu in 2016. As government slash spending (the Saudi Arabian budget deficit is 20% of GDP this year), economic growth rate and corporate profits will fall. Fiscal austerity and a liquidity squeeze in the regional banking system mean protracted bear markets in GCC equities and property. The dollar currency pegs mean a monetary ease to offset the deflation shock is impossible. In a liquidity crisis, you sell what you can, not what you must. This is the reason a liquid megacap like Emaar has been slammed to AED 4.5 even though it has slashed its debt, listed Emaar Malls, doubled operating margins to 60% and presold its 2017 delivery schedules. The twilight zone of markets is the value zone of Mattinomics.
The Federal Reserve prices 100 basis points in rate hikes in 2016. This means three month EIBOR, which rose from 0.60 to 1.05 basis points in 2015, could well rise to 2.5%. This is the reason property finance and bank funding costs will surge. The US data momentum is accelerating with 290,000 new jobs in December. So the King Dollar trend continues and Brent crude could well fall to $20 this spring, the Goldman Sachs target.
World trade has collapsed. The Baltic Dry Freight index was 4000 in 2010 and 1000 in early 2015. It is now 378. Credit risk has surged for risky borrowers, oil drillers in Texas to sovereign borrowers in Africa, Southeast Asia and the Gulf. Stan Chart cut lending lines to 8000 small businesses alone in the UAE in 2015. The world’s biggest shipping empires face failure despite lower energy costs. The $3.8 trillion emerging market corporate debt is a systemic threat in international banking.
The business cycle in the Gulf faces its biggest downturn since 2008. GCC equities have underperformed the Morgan Stanley emerging market index by almost 50% since 2011 and money supply growth has now turned negative in the UAE, the most diversified, networked, globalized economy in the Gulf.
I am alarmed by the grim new realities of European banking, 70% of foreign bank lines to the GCC. I am alarmed by the new credit risk paradigm in energy that will mean spread widening in the MENA debt/sukuk market. I am alarmed by the scale of economic adjustment that is needed to stimulate growth and the feebleness of the reform agenda. As in 1997-98 and 2008-09, King Dollar means financial distress and secular bear markets in the emerging markets. Yet it is always darkest before dawn. So I go value hunting in GCC equities.
Stock Pick – J.P. Morgan is the world’s safest bank
J.P. Morgan Chase is a bank I have literally studied my entire adult life, as I spent my salad days on the trading floor of 1 Chase Manhattan Plaza in New York. J.P. Morgan’s blowout 1.32 EPS on $22.89 billion in revenues beat Wall Street consensus and triggered a 300 point rally in the Dow that did not last. The bank earned $24.44 billion in 2015. Its dividend yield is 3%. The shares are undervalued at 56 and I will use the implied spike to sell high delta put options in Chicago. After all, the shares are down almost 20% since the summer peak. This is not irrational since both the Morgan Bank and Chase Manhattan (the Rockefeller bank, as one Saudi prince called it in my presence) has traditionally dominated the global loan syndication and bond issuance market for the Seven Sister supermajors.
Energy loans are the Achilles heel of J.P. Morgan, with an estimated $45 billion exposure so a rise in loan loss reserves is inevitable given that Brent has plummeted to $30 a barrel. J.P. Morgan will be hit if crude oil plunges to $20 as global storage capacity runs out, as happened in 1999 when oil bottomed at $10. Energy loan reserves were thus the target of the wicked witch of Wall Street on Friday.
J.P. Morgan’s “fortress balance sheet” (Jamie Dimon’s words) and stellar 16% US corporate/consumer/auto loan growth make me go gaga on the latest incarnation of the House of Morgan in my lifetime. The Basel Tier One capital is 11.70%, the fall in cost of credit metrics and a 7% fall in costs are all impressive in their own right, as is the 9% return on equity.
J.P. Morgan now trades at book value and 9.4 time forward earnings. This makes no sense for five compelling reasons. One, J.P. Morgan has the least volatile, most diversified earnings base of any US money centre bank. Two, tangible book value is $48, a natural bottom for me even in a worst case scenario. Three, the investment bank is Jamie’s crown jewel, with 4Q revenues $2 billion, up 10%, a beauty for a global bulge bracket firm. Four, J.P. Morgan has promised that payouts/buybacks will rise and the Fed stress tests are no longer an inhibiting factor. Five, the litigation risk cycle has peaked, though the bank still swallowed a 2 cent legal charge.
In the past, I dealt in IPO’s, new issues securities and derivatives with the institutional bank in London. So it is only poetic justice that I take an retrospective, even nostalgic take on Morgan, Morgan the Financial Gorgon over time – 1990 in my case. As the global economy turns ugly, I see J.P. Morgan as a safe haven against the next Lehman fiasco in international banking. No sane US president will break up J.P. Morgan at a time when China is in financial chaos and oil/commodities spread deflation risk across the world’s black gold/red metal provinces.
J.P. Morgan has the economies of scale, the global network, the balance sheet, the technology superstructure to serve the crème de la crème of corporate America. Think derivatives. Think Eurobonds. Think cross-border mergers, merchant payments and project finance. Consumer banking alone can add another $1 billion to the bottom line in 2016, thanks to a robust US housing, consumer credit and auto loan market.
The last decade was tough for the bank. The 2008 financial meltdown, the shotgun marriage with Bear Stearns, WAMU, the London Whale scandal, the “too big to fail” capital surcharges and People’s Commissar Barney Frank’s diatribes against Jamie and his merry men.
J.P. Morgan has the lowest cost deposit base in global banking and the most credible efficiency ratio management program. Sometime in the next three years, J.P. Morgan will earn $28 billion. Its liquid assets are $500 billion, one fifth of its $2.5 trillion balance sheet, making it an ultra safe, bank in a fragile, dangerous world. The Fed will engineer a steeper US Treasury yield curve and boost banking net interest margins. J.P. Morgan is in my view, the world’s safest, best managed bank, a worthy legacy to the memory of John Pierpont Morgan, king of Wall Street in the Age of Ragtime.
Wall Street – The “Made in China” crash has gone global!
There are none so blind as those who refuse to see – especially if they are leveraged with 50% loans to value. So even my closest friends pooh poohed my call for a global financial crash in October 19 2015 “Is a financial crash looming?”. I was horrified by the events in China, the free fall in mining/oil, the meltdown in emerging markets, liquidity shocks in Wall Street ETF and junk bond trading desks, geopolitical risk in the Mideast, Russia and North Korea, the unmistakable metrics of fear evident in volatility forward curves, tough love from the hard money gents on the FOMC. Now a global financial crash is happening in real time in my Bloomberg screen. Ask not for whom the bell (of the margin calls?) tolls. It tolls for the thee duckies! So what next?
I see Citigroup with a blowout quarter yet its shares fall 5% to $43. I see crude oil trade at $29 down 17% in the past two weeks alone. I see the high beta biotechs and FANG megacaps fall 20% (Celgene, how I love you below 90 and now, thanks to CBOE puts, you can be mine!). Shenzhen has lost 25% in January alone.
Emerging markets and GCC equities face the mother of all margin calls even though many Gulf shares trade below book value. This is 2008 all over again. Those who do not grasp the macro significance of the Crash of 2016 jeopardize their financial survival. Risk is a four letter word. So is ruin.
What are the macro smoke signals? Hedge macro risk as King Dollar goes on a rampage once US data momentum reaccelerates. Earnings growth will be a disaster, emerging markets risk is leprosy in times like this. This is no time to view the world as an ostrich, though I lose no opportunity to broaden the continually expanding frontier of my own ignorance by hibernating in my man cave aerie, a broker free zone high above the Gulf shore. The name of the game is return of faloos, not return on faloos.
Central banks must never be trusted to defend the interest of investors. As Yeats said, the best lack all conviction (Dr. Rajan) while the worst (Bubbles Greenspan, “subrprime will be contained” Ben and Mama Janet!) are full of passionate intensity. So yes, things fall apart, the center cannot hold, mere anarchy is loosened on the world. What Sigmund Freud says about death wishes and Werner Heisenberg said about subatomic particles (the act of observation changes the nature of the object being observed. Dodd Frank!) matters more when markets go ballistic than what Yellen, Draghi and Marky Mark says about interest rates. So when in doubt, cut it out. Neural networks will determine the epic contest between Mr. Market and Johnny Habibi of Shwarma Capital. Safe havens? Ireland, the lovely emerald island of Joyce and Nora where it is always a long, long way from Tiperary, it’s a long long way to go.
Denial no longer makes sense and the wrath of the margin clerks is all too real. Private Bankerji will turn into a heat seeking missile when the Big Boss orders the epic margin calls. Note that a spike in volatility forces bank to slash leverage gifts. J.P. Morgan’s immortal advice in the Panic of 1907 “Liquidity is like a cab on a rainy night. It disappears when you need it the most”. So avoid rainbows, pipedreams and $60 billion unicorns – like Uber. Trillions of innocent souls will be zapped at the speed of light into money heaven. Leverage is now the kiss of death.
China’s $10.4 trillion economy will have its own lost decade. Commodities markets could have a 20 year bear markets, as in the 1990’s. The “Made in China” global recession scenario I outlined last summer is now a reality and yes, its dark side will hit the US economy and the leveraged netherworld of global baking.
My bearish call on India last spring (27,000 Sensex levels) is in the money. How can Dalal Street trade at a valuation premium on the eve of a systemic banking crisis that will throttle loan growth and the rupee? Asia now trades at 9/11, Hong Kong SARs and Lehman lows. Asia prices in a global recession, as I expected. MS Asia ex Japan trades at 1.2 times book value. Yet who believes book value amid global crisis? Note the Hong Kong dollar has sagged to 7.79. Somebody very big is targeting the peg. Somebody very big is taking on the Red Emperor of the Middle Kingdom. Who next? what next?
