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Insights on the impact of US elections on markets
Michelle Martin, interviews Tong Hoe Sng to discuss the breakdown of JP Morgan Chase and Citigroup’s earnings and loan provisions.
Martin and Sng also discuss how investors should position their portfolio amidst the volatility and emphasise cycles in the US economy. View the full transcript of the conversation below.
Michelle: Good morning Tong Hoe, how are you?
Tong Hoe: I’m fine, thank you.
Michelle: Two of America's banks are showing marked improvement in earnings. JP Morgan Chase reports US$9.4b profit for the third quarter of the year, Citigroup netting more than US$3b in income during the same period. More importantly, both banks are setting aside fewer funds to cover potentially bad loans. What do these results tell us about the bank's financial health?
Tong Hoe: Earnings that came out for JP Morgan and Citigroup were both definitely better than expected. If you look at JPMorgan’s revenue around US$30b, it was basically quite flat compared to 2019. However, what was surprising was the fact that the trading revenue was up about US$7b. That's up approximately by 29% year on year.
Citigroup’s fixed income and equities trading revenue of about US$4b was also up about 17% year on year. As you indicated, both also reduced their provisions for bad loans with JP Morgan setting aside approximately US$611m as compared to US$10b in the second quarter. Citigroup is also looking to set aside proximately US$2.3b as compared to about US $8b in Q2.
What is critical is looking at the company's guidance for clues for the future. What these results indicate is that the pace of economic recovery is uneven. There will be pockets of the economy that would perform better than others. Take, for example, the travel industry in the US, it's basically at a standstill.
Michelle: The banks are doing quite well now, why is that and where are they making their money?
Tong Hoe: The fact that interest rates have been low helps in terms of corporate borrowing. Because rates are low, most of its earnings came from trading activities. Putting money in the banks isn’t going to earn people much money so they’ve decided to go into the markets, which is why the US market has been doing so well. It is purely liquidity driven and I guess with the US economy slowly opening up, that should work quite well for the banking sector in general.
Michelle: What do you think of the earnings result against the backdrop of the state of the US economy? Does it say something about the economy if these banks don't have to set aside more for bad loans?
Tong Hoe: As the economy opens up and more activities come on stream and businesses start expanding again, (especially in the healthcare sector where there’s a race for a vaccine) I would say looking ahead, it does bode quite well for the financial sector in the US.
Michelle: We've heard today that two attempts at a vaccine have stalled with Eli Lilly, Johnson and Johnson both reporting setbacks on that front, do you think this is going to add significant uncertainty to the market?
Tong Hoe: Yes and no. When pharmaceutical companies start going into third-stage trials, there are going to be setbacks and that is to be expected. Even though we know a lot more about the coronavirus today compared to the beginning of the year, it is still quite a mysterious virus and there is still a lot to learn about it, so setbacks aren't surprising at all. Each year thousands of drugs are trialled but only about a third realistically obtain FDA approval and come to market.
Michelle: On the banks, JP Morgan Chase and Citigroup, what do you make of investor reaction to the earnings? Both bank shares are trading down with Citigroup showing a greater decline than JP Morgan.
Tong Hoe: I think what people have done is basically take money off the table and are looking further ahead at the US elections and unemployment numbers in the US. It’s critical we look at the short-term versus the long-term unemployment rates. The major worry is long-term unemployment because that affects consumer spending, and confidence and that contributes to two third of the economy’s GDP.
Depending on businesses, whether they’ve changed their model, with more still communicating virtually and what sort of transformation that is going to take place, that’s one of the reasons people are saying, “OK I think the markets have been kind to me, I would like to take some money off the table, take a step back, and perhaps wait for the outcome of the US elections”, which is really quite close.
Michelle: So, what are you telling your clients? Is the lack of a stimulus package or anticipation of one adding to uncertainty in US markets? Should investors be positioning themselves accordingly?
Tong Hoe: As of now, the November election is pretty tight even though there are talks about a potential stimulus package. If I were a Democrat, I’ll probably say no and stall as long as I can, especially if I think my candidate is going to win because I'm not going to gift something like this to the incumbent. For the Republicans, they would probably prefer to go all out to come up with a stimulus plan so it's a lot easier to go out to the Electorate and say this is what I've done for you. There's going to be a volatility index for sure and if you've already made money, maybe consider taking some money off the table, and be a little patient.
Michelle: Great advice there, it's been a tech driven run but what do you think of emphasizing cyclicals like industrials and healthcare when you look at the US economy?
Tong Hoe: Technology has basically driven the market and looking ahead, one cannot avoid technology. If I had to look at cyclicals in the long term, cyclicals may benefit as people move out of technology. It’s the classic battle between value and growth. For value, a little inflation is required but we are not seeing any signs of inflation at the moment.
Healthcare is an area that may do well while the development of a COVID-19 vaccine is pursued, however, this also hinges on the outcome of the US elections.
A Biden victory may affect the big pharmaceuticals as Democrats will continue to push for affordable healthcare for all, which means lower medical cost and insurances. If we have a Trump victory, then I would say it's status quo, whereby affordable care and health care will continue to be pushed onto the private sector.
Another factor to consider are the tax policies of Biden. If he wins, the likely scenario is higher taxes for the wealthy. Whilst a Trump victory could mean tax policies will continue to benefit the wealthy and big corporates.
Michelle: What are you advising your clients? Are you seeing clients shift their portfolios in anticipation of possible election outcome scenarios?
Tong Hoe: It’s difficult to call especially with the elections coming closer and Trump being back on the campaign trail. There are numerous reports that say Trump could possibly win another four years and then there are also those that are saying Biden is far ahead not only nationally but also ahead in some key battleground states. I think it’s going to be a close call.
Regardless, I think people could look into companies with an ESG focus. It's a concept that has been talked about but never quite committed to until now. People today tend to talk more about the environment, sustainability and governance, so I think that will have a higher profile as time goes by. In terms of renewables and sustainability, I may suggest considering allocating some money into companies that are governed by ESG criteria.
Michelle: So look away from energy?
Tong Hoe: I think renewables may benefit, as electrical vehicles and battery prices start coming down. In time, it is probably going to cost the same to buy an EV as compared to a normal combustible engine car. A Biden victory may give renewables a flip, while a Trump victory would be status quo on fossil fuel, as he does not seem convinced about the science behind climate change.
Michelle: What are you looking at now?
Tong Hoe: Central banks have indicated they are happy to keep interest rates low or where they are for the next year or so. For the time being, the race for yield is still going to be very much in play. What one could also do is selectively look at equities of companies that are still paying dividends, have good cash flow and a decent strong balance sheet.
Michelle: Thank you for today Tong Hoe
Tong Hoe: Thank you
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