Ep.102: J.P. Morgan's $1trl Target & US Data Sours Stocks Sentiment

Hello and welcome to episode 102 of the Market Maker podcast. And Piers, I can see you're joining me from a different location. It's either Shoreditch in London or New York City. Where are you?

Uh, New York City, baby. Uh, yeah, landed— well, landed yesterday. Yeah, in the Big Apple.

Um, is this business or pleasure?

Business. Yeah, a couple of, couple of big things going on actually. Just so I've got a big, um, big event I'm running for Citadel tomorrow. Well, tonight and tomorrow. A bit of a networking session tonight. Um, I think it's 130 students that they've sort of, um, selected from universities all over the US. And they're coming up to New York and a bit of an event tonight. And then, yeah, we're taking them through our market making and, uh, quant trading simulation tomorrow. So yeah, and then I got a bit of time for Sunday. I got working Saturday but Sunday free. But then next week I've got a big Morgan Stanley simulation going on on Tuesday. Um, yeah. So hitting some, uh, some big clients, but then, you know, sightseeing on Sunday maybe. Had a little stroll, my hotel just around the corner from Central Park, actually just a couple of blocks away. Um, so yeah, get a bit of tourist action in somewhere.

Okay, well, you know, when I'm in the Midlands next week, I'll, um, you know, not downplaying the, uh the quality of the Midlands in the UK.

But yeah, we should, um, yeah, that's true actually. I get New York, you get Birmingham.

Yeah, nothing wrong with that. Right, so on the agenda for this week then, want to talk about, um, a couple things. Gonna blend a bit of a single stock story and a bit of education around how some financial institutions structurally are different from others, because I know that's important, particularly for students who are applying to these firms, to understand that unique difference between investment banks. So not even going as far as what's the difference between sell-side, buy-side, what is the actual difference between investment banks themselves, like Goldman's to JP to MS and others. So we'll touch a little bit on that. And then we'll talk macro because this week we've had, um, US Q4 second reading of GDP, we've had the Fed's preferred inflation figures, PCE, and we've also had the latest FOMC minutes. So want to get your take on those events and see whether or not that's shifted the view on markets at all going forward. So starting off, JP Morgan, they could have exclusive access to the VIP club the $1 trillion club, which is normally reserved only for tech—

big tech people, tech firms. Who's in that $1 trillion club at the moment? It's, uh, well, Apple, Google, Microsoft, Tesla briefly, didn't they? I think flirted with it and then obviously got chopped back. Um, what about Facebook? They're not— are they in it anymore? Actually not sure. No, but they've also been hammered over the last sort of 12 months.

But so the idea here is then that JP Morgan could become part of that club and, you know, from a very top-level perspective, kind of make sense with tech. Or perhaps you could explain that. Why are the tech valuations so wildly different to a bank, for example, from a, from a sector equity perspective?

Uh, one word: growth. Or I should say maybe two words: growth potential, right? These tech firms, you know, are growing, yeah, their top and bottom line growth rates, so their revenue growth rates and their profit growth rates, are way higher, way faster than, you know, most other sectors and, you know, banks certainly. Um, and so that, that rap— more rapid growth rate is why you get higher valuations, because you're seeing some of that future growth being priced into the market cap today and then being cut back because interest rates are rising, right? Exactly. So 2022 was definitely the interest rate sensitive sectors. So, and certainly tech are right up there, top, probably top of that list. They've been hurt the most in terms of their share prices dropping in 2022 as interest rates have risen. And yeah, one, so one of the angles about that future growth, right, being embedded in today's share price Well, the value of that future growth has been discounted because of inflation and higher interest rates. And so if you like, the value of that future money, it has dropped, is now less valuable today. And that's why share prices come down in those interest rate sensitive stocks.

Okay, so before I, um talk about the $1 trillion, I must put the caveat on they are expecting that to potentially happen quite a way off. I think it was 2030 actually where they think that JP could hit that milestone. I think their current market cap is something like the $400 billion.

$411 billion.

Okay, yeah, so around that kind of level gives you an idea.

Yeah, I mean, I think—

go ahead.

This is like So this was a headline earlier in the week, right? And like all good headlines, um, they get attention and they get clicked on. And, and this was, um, in, in true classic sort of equity research, um, style. You know, as a person, if you're an equity research analyst, um, then, you know, you want to become known, right? Your profile, you want it to— you want, you want potential customers to be obviously aware of your work and what you're doing. And one way of kind of increasing your, your, your awareness out there is by, yeah, generating big headlines and people clicking on them and then reading your stuff. So this actually came from a Morgan Stanley— ironically came from a Morgan Stanley equity analyst who came out with this piece. So they obviously cover the banking sector, US, US large-cap financial sector, is Grazek. That's the name of this Morgan Stanley equity research analyst, Betsy Grazek. And so she put this piece out and it had the headline, yeah, JP Morgan to whatever I can't I don't know the exact headline, but to join the $1 trillion club. Yeah, when you delve into it, she's very bullish, obviously. $411 billion is the market cap today. And so she's saying it's going to more than double. But yeah, her caveat is not until 2030. So we've got 7 years to go. She does say— well, actually, no, sorry. She said actually her central theme— apologies— was that it would reach $1 trillion in 12 years' time. But then her range is the earliest it might happen is by 2030, but her base case is 12 years. So 2035, I mean, that's a hell of a long time. And trying to make predictions that are 12 years into the future are, yeah, I'm not sure there's too much merit. That should be placed on this kind of ultra-long-term forecasting. But, um, her key central theme, as opposed to those tech stocks which are interest rate sensitive, um, it's the banking sector that's the exact opposite. So banks are one of the few sort of companies that actually benefit from interest rates going up. And so her kind of whole thesis is about interest rates will stay high for longer, and so this will feed into, you know, much better, um, net interest income revenues, uh, for these big giant banks.

Yeah, I was just having a look at a bit of a breakdown of the different revenue streams for some of these investment banks, and just to give you some context of numbers, I was looking at the Goldman Global Banking and Markets. So Goldman's been streamlined into 3 divisions in this current restructuring they've been going through. So there's Global Banking and Markets, so this is kind of your trading and your IBD type packaged into one unit. Then you've got Asset and Wealth Management, then you've got Platform Solutions. Now when you combine— so When you think of Goldman's, you think, yeah, they're the, the leader in IBD. They do all the deals, obviously trading securities across different derivatives. So they generate about $6.5 billion, or they did in their last quarter in terms of their earnings statement. So $6.5 billion US dollars. If you bolt in asset and wealth management, takes up to $3.6 billion. So you're talking around $10 combined, right? Yeah, when you look at JP Morgan, so not only is their corporate investment bank already bigger than that, just by a whisker, just short of $11 billion, their consumer and community banking area— I think if I said to most students, do you fancy working in consumer and community banking, um, or do you want to work at Goldman's? But that consumer community banking revenue is far greater the entire pool of revenue across the in all of the divisions of Goldman's clocks in just shy of $16 billion. Um, quite incredible.

Yeah, and JPMorgan is the biggest bank. I mean, actually not sure what the valuation of Goldman's is, um, but it's certainly— no, I know, you know, there's— yeah, there's kind of— I guess the Goldmans and the Morgan Stanleys are a little bit more niche, even though they've been trying to broaden out and diversify and try and get into the kind of commercial banking gig. But broadly, you would say that they're more niche where it's more about global markets and IBD. But then when you think about big banks like JPMorgan, Bank of America, Citigroup, they are giants of the commercial and retail banking world. And so JPMorgan's business, as you're saying there, like half of it— more than half of it, I believe, or about— yeah, more than half of that. Well, about half is from consumer and community banking. And that's their kind of big underlying engine. And that engine is firing into life. That engine's been a little bit squeezed for a decade. Because interest rates have been at zero. And now the interest rates have elevated pretty sharply. This, this big engine that they've got is really firing. And so why does that happen? Because the whole point around consumer and sort of corporate banking, it's how do banks make money. It's about borrowing money on the short term by getting individuals to deposit their salaries and their whatever other income they've got coming in and deposit your money at the bank, and then the bank pulls all those deposits and lends that money out to their— well, other individuals through things like mortgages, but other corporations and so on. Okay, and we talk about something called the net interest income. So that's just the difference between the amount they're paying to depositors. So what's the interest rate on deposits versus the amount they're earning when they lend the money out. And that gap, the spread between the two— so the interest they pay on deposits is, is really low, and the interest they, they charge on loans is, is much higher. And as interest rates rise, that spread between those two can increase. And this is why, therefore, the revenues and in the end the profits that come from that part of the bank have risen sharply. So 2022 has been a really good year for these big banks that have the giant underlying consumer and corporate banking divisions. It's something Goldman's been desperately trying to break into, and I've spent a fortune trying to do it over the last— well, you'd probably say 10 years, but especially over the last 5 years. And yeah, this was one of the revelations a few weeks back when Goldman's had their earnings, and their earnings were shocking. And it was the owning up, it was the fessing up that our strategy trying to break this commercial banking market, our strategy has been terrible and it's failed. And we've spent a whole load of money and we've not got very far. And so that's why Goldman's, who have been trying to build that kind of same similar kind of engine that JPMorgan have, Um, haven't quite yet managed to figure it out.

Yeah, I think I remember reading an FT newsletter and they were talking about if you're an investor, it's not about trying to pick the best bank, it's about diversifying which banks you are invested in. And so it's not like you're trying to bet on Goldman's will be able to diversify and mitigate the volatility on the dependency of fee-generated business, which as we saw is quite susceptible to economic and macro conditions. It was— no, they will outperform, like we saw with record-breaking fees during the initial onset of the pandemic.

Yeah.

And through '21. And then the other banks will pick up and, and not— and balance, counterbalance that in the current situation where we're at at the moment, in a potential slowdown environment.

Yeah, and you could say that JP Morgan's a one-stop shop, right, for an investor who you're looking to get exposure across the sort of banking elements and divisions. You could say that JP Morgan's one of those ones that has, has it all, right, in that it's got the big consumer banking arm, it's got massive investment banking arm, it's got a big asset management division. So it's— yeah, as a business, it's much more diversified than banks like Goldman's, which makes it a safer investment. And, and that's why the JP Morgan share price is a lot less volatile. And back to this analyst at Morgan Stanley, um, Grasek, and she's saying that yes, so her thesis is based off the idea that there'll be a soft landing and so the Fed will carry on hiking and they'll maintain rates at a higher level for longer. That then benefits JPMorgan. She's also saying that you'll get a return of the IBD fee generation that had such a shocking year in 2022. And if the economy soft lands and we start to get an uptick, then you should see a return to those IBD revenues, which would benefit the Goldmans of this world, but definitely would also benefit JP Morgan. So they could be strolling into like, like the perfect scenario where all divisions are firing, um, perhaps later this year and maybe into 2024, which is why I think Grasseck is so bullish, um, on, on JP Morgan stock.

Yeah, I think the other element with JP that makes it quite interesting medium term, so let's say the coming years is also their investment in technology. Because I remember, I think it was last year that they said that they were gonna— I can't remember the timeline of the investment, but they were going to invest about $12 billion in a broad range of technologies simultaneously. Um, and I know that their team of technologists is like— they're aiming, I think, for 50,000, which is larger than most other banks Brutal headcount.

I mean, I guess that's one of the big risks for these big giant incumbent banks, um, is their legacy tech. And you get these new challenger banks coming along, uh, like banks like Starling or, um, Revolut and all these kind of players that are brand new. They don't have a legacy tech stack, they're just coming at it with brand new tech. Building it from scratch. And you get these super slick apps that are really intuitive to use and are fit for purpose for the modern age, right? But these big banks, they're trying to get their old tech stack and trying to revolutionize it and make it new and shiny and pretty is a mammoth task. And is costing huge amounts of money. And of course, the longer it takes them to do it, well, the more market share they lose to these new upcomers. And so, yeah, they've got to go big investment side. They are the giants, like the JPMorgans. They're not going to get washed away by this new wave of kind of challenger banks.

But I guess strategically they approach this— it's a two-pronged attack. Build out your headcount in your development team and then also get quite aggressive on your acquisition strategy, right? At the end of last year, they acquired a payments startup called Renovite, which is basically a rival of Stripe and Block. Yeah. And then that was the latest in a string of fintech deals that they'd been doing. I think they acquired, um, 5 fintech startups as well just as soon as the pandemic hit, they were straight on it. So I guess having the ammunition to be able to fire as well is another benefit that someone like Goldman's might not have with that variability. Because I was just looking, the revenue of Goldman's this last quarter reported $10.6 billion. When you actually put in the operating expenses, everything else, you actually just at the end you're left with— well, I say just left with— you're left with $1.3 billion US dollars from $11 billion revenue. With JP, $34.5 going in, $11 as net income billion at the end of it. Yeah.

So 10x the net income that Goldman's had.

Yeah.

And that's obviously a big war chest to put to work. Yeah. I mean, you always get the big boys having the competitive advantage. I'm surprised the regulator I mean, this is another thing, right? Obviously, the regulator— I don't know if you go down this rabbit hole, but the regulator is so obsessed with big tech and trying to break up big tech and trying to stop big tech. Um, and yet you have these other giant industries and they just don't care. And you get the JPMorgans hoovering up, you know, all these acquisitions and, you know, solidifying their sort of market dominance.

And yeah, how are these politicians going to be able to trade if they sever those relationships? Come on. All right, well, look, let's pivot and talk a little bit about the macro scene just for 5 or 10 minutes, um, starting off with the economic data points that we had. And I guess that kind of combines with the minutes because US— it was a second reading of fourth quarter GDP earlier in the week, and it was previously estimated at 2.9%. The advanced reading got downgraded, if you like, to 2.7. However, the Fed's preferred inflation figure, PCE, was revised up So you've got slightly more aggressive slowdown with a slightly more concerning inflation situation, and that does kind of feed into the summary of what the Fed was saying, right, which was kind of, we're downshifting in rates but the concern over inflation remains high.

Yeah, I think it's been, uh, like, broadly Obviously January and the start of February were just rip-roaring weeks for markets, right? And just bounced like way faster than almost everyone was expecting. And that was all off the idea that the Fed are gonna stop hiking. They might, they might do one more quarter point hike and then that's it. And then we may well see a recession a mild one towards the second half of the year, which means we'll get some rate cuts. But what's happened in the last couple of weeks is now a kind of, uh, a bit of a flip of all that argument where we're now feeling a little bit nervous because the data that's been coming in has been uber strong. So the US economy is actually firing, right? We had a really strong non-farm payrolls report for the month of January a few weeks back now, but that was like stellar, massive, um, huge surprise. Then we've had some really strong, you know, PMI data. We had a crazy strong retail sales number out of the US, and it's like, what, what is going on here? How is this economy staying solid in the face of this massive interest rate hiking onslaught from the Fed. I think it surprised everyone. We were expecting the economy to turn and that feed into all that narrative about the Fed stopping their hikes, but it hasn't turned. In the minutes, I mean, the minutes, I would say the Fed minutes, so just for those who don't know, The Fed have a meeting every 6 weeks, but then 3 weeks after each meeting they release the, the minutes from that meeting. It just gives you much more detail as to what was discussed and what the members were thinking. Like, for example, here's a quote from the minutes that kind of was picked out, um, that's led to some of this market downside. The quote is, the participants favoring a 50 basis point increase. So remember, last meeting they hiked by 25 basis points. It was a unanimous decision, but some had wanted a bigger 50-point hike, right? And those that wanted that, um, they noted that a larger increase would more quickly bring the target range close to the levels they believed would achieve a sufficiently restrictive stance. Um, so this was kind of picked out by the media, and so yeah, it's now playing it, but those minutes are a bit you've got to realize those, those minutes are from the meeting in January, which was before all of this strong data. So if you now add in all the strong data, and there's already some people on that committee who wanted 50, and when they meet next time in 3 weeks to come, if we continue to get strong data, then I do think that you will see a slightly different Fed than we saw back in January. The Fed were very dovish in January, and I think they're probably going to have to reverse that to an extent, yeah, their next meeting. And that's what markets are reacting to now. That's why you've seen some pretty decent downside, um, in, in a lot of these markets. Like, for example, you know, if you want to just pick the S&P, um, you know, we've dropped from 4,200 back to below 4,000 now. Um, so that's more than a 5% drop just over the last couple of weeks as we've been getting all this super strong data coming in.

Yeah, and I can see that the market pricing at the moment is 76% in short-term interest rate futures, indicative of that meeting in 3 weeks, of a move at 25, 20, right?

So 75, 25, 25% still looking for 50, and I assume that's gone up then, the The likelihood of a 50 hike has increased over the last couple of weeks.

It was like north of 90% not that long ago before—

for a 25.

Yeah, 25. Yeah. The one person then that's feeling a little bit better, I guess, is our, is our buddy Mike Wilson at MS, the uber bear.

Yeah.

Um, but just to, you know, kind of stoke the flame a little bit further, he came out with his um, his report called The Death Zone, and he was talking about basically, um, a measurement, so equity risk premium, and he was looking at that, and basically on that measurement he's saying that the S&P 500 has fallen into the death zone, which means then in that scenario the S&P could slide a further 26% from its current levels. Which would be talking— well, we'd be talking, uh, 3,000.

Wow.

We're just— we've just gone through 4,000 at the moment. Uh, obviously that would be his worst-case scenario. He was basically talking about, again, same things really as you were there, which was recent data suggests the economy might be able to dodge a recession. Uh, they've also taken the possibility of a Fed Reserve pivot off the table. Therefore, that doesn't bode well for stocks as the sharp rally this year has left them the most expensive they've been since 2007 by the measure of their equity risk premium.

Yeah. I love it. If you stumbled across this podcast and you knew nothing about markets, and then you hear that, you go, hang on, the economy's going to avoid recession and therefore stock markets are going to collapse. It's like, what? Hang on, no, you've obviously said that wrong. But it's not wrong. That's exactly the case. Good news is bad news. The better the economic data, the worse news it is for share prices because there won't be the Fed pivot. And yeah, it's just quite— it's a funny old world, isn't it? And quite an important point to understand the behavioral side. Of how markets go about their business.

But yeah, and a good point to conclude then is that markets, again, if you are new to the game, the markets are forward-looking. And so yeah, trying to just deal with this changing of situation over the last— it's been a really interesting couple of weeks actually. We've really shifted through the first 2 months of this this year. Yeah, quite a significant sea change is, is underway at the moment. So we'll see. Um, it'd be interesting to see where, um, the S&P closes today because we're right down at what was the low point of yesterday's insight at the moment. So whether we close above or below there will be quite telling.

Yeah, and it's quite— there's actually a really important trend line on the S&P that goes back to the October low And it takes in the October low, then the sort of December, January low, and now where we are now is kind of the third test of this trend line. So technically really important around this 4,000 handle. And yeah, where we might close, where we might close out the week, um, could be pretty significant. And, you know, and as ever, we're data dependent. You know, the Fed say that, but also markets are as well. And I tell you what, if this US data continues to come through strong, then yeah, this market's going down.

Okay, well, look, while you're in New York then, if you see Mike, just buy him a beer and cheer him up a little bit. Tell him to stop being so doom and gloom.

I'm not sure that's possible.

All right, cool. We'll end it there. Thanks very much, Piers. Enjoy your time, uh, in the Big Apple, and I'll see you next week.

Yep. Cheers. See ya.

Take care.