JPMorgan: I’m watching the buybacks
When the leading banks in the US release earnings, the world pays attention. I hold both JPMorgan and Goldman Sachs as core positions in my portfolio, giving my money direct exposure to Wall Street’s finest minds. Deep capital markets, a steady stream of new listings and the general uptick in wealth in the West have proved to be excellent drivers of returns. But now the concerns about tariffs and recession risks suggest the party might be over, or at least that the music is going to be turned down. What does this mean for my US banking exposure?
There’s very little value in debating whether US President Donald Trump’s approach is the right one. It’s his — shall we call it unique — negotiating style that is coming through here. For decades, China has been growing in power and moving far beyond just being an outsourced factory, while the US has been running its economy so hot that gold and even bitcoin evangelists have had no shortage of stats to point to about inflation and dollar risks. The chickens have come home to roost and while Trump’s style is far too aggressive for most tastes, the reality is that something needs to be done to address the trajectory. The only certainty we have at the moment is uncertainty, so prepare yourself for a yo-yo year when it comes to sentiment.
Large banks are always tied to broader macroeconomic trends, which is why South African banks have underperformed US equivalents over the past decade. Banks need economic growth and positive sentiment that encourages people to borrow money for assets or invest in equities, leading to growth in core product offerings such as loans and wealth management. The largest US banks include a substantial component of investment banking fees in their earnings, with advisory income at its most lucrative when corporates spot opportunities to grow. South African investment bankers will tell you that it’s possible to earn fees by advising companies on how to shrink into prosperity, but it’s certainly not as much fun (or as profitable) as earning fees on capital raises and M&A transactions. The abovementioned drivers of earnings have been extremely favourable to US banks, which is why JPMorgan has delivered a 10-year compound annual growth rate of 13.4% in the share price — while paying dividends along the way! And remember, that return is in dollars.
Against this backdrop and long-term trend, the latest quarterly earnings reflect year-on-year growth in earnings per share of 14% at JPMorgan. Return on equity (ROE) was 18%, driven by growth in highly lucrative areas such as investment banking fees and asset management. There’s little sign of concern here, until you read through the earnings transcript and see some of the comments concerning credit loss allowances. The CFO of the banking giant explains that it has decided to assume an increase in the weighted average unemployment rate from 5.5% to 5.8% in light of recent economic events, with JPMorgan’s economist giving a recession a 50% probability.
In South Africa, nobody blinks an eye to a change of 30 basis points (bps) to our unemployment rate, as the rate is already so high that 30bps is a small percentage change. But on a base of 5.5%, 30bps is ironically an increase of 5.5% in the weighted average unemployment rate. That’s a material difference. When you apply that change in assumption to a number as large as JPMorgan’s $27.6bn total allowance for credit losses, you end up with a move of $973m in the allowance.
The stakes are clearly high. Fortunately, JPMorgan has a famously resilient balance sheet. It ended the quarter with a CET1 ratio of 15.4%, which puts the bank way above the minimum equity levels that need to be held. In fact, much of the recent questioning from analysts has been about how to reduce that ratio, as holding onto too much equity becomes a drag on ROE. They aren’t believers in special dividends at JPMorgan, with share buybacks as the preferred approach to reduce the CET1 through returning capital to shareholders. Unlike so many other companies though, JPMorgan won’t do higher buybacks unless it believes its stock is cheap. This positions it perfectly for accelerated buybacks into a potentially weak market this year.
So, am I panicking or selling my US banking exposure? No. If anything, I’ll track JPMorgan’s buybacks and use that as an indication of when I should be adding to my current position.
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