Avoid Banks, More Downside Coming: Charles Peabody (Podcast)

JP Morgan in particular started out with a bang, but shares have since gone negative. Joining us now as somebody who perhaps isn't entirely surprised by this, Charles Peabody as president of Portala's Partners and Charles, I'm so glad you're joining us today because just Wednesday you actually downgraded your rating on JP Morgan too, a neutral from a bio believed today's results edify your decision in your view or did it make you rethink anything? Um, just a quick clarification,

I went from a neutral to a sell on Yeah. Um, Listen, when you when you think of the themes that are out there that that the analysts are espousing to try and get people to buy these banks. There are three major themes. One is um by those banks that have big capital returns. The second is by those banks they're showing positive operating leverage and and the third is by those banks that have low loan to deposit ratios because they're not going to be as effected by an increasing

deposit data. And if there's a uh theme that I think is running through the weakness in the stocks today, it has to do with the lack of positive operating leverage, which you didn't see at JP Morgan, you didn't see at p n C. And that gets back to the fact that revenue growth is starting to slow um at the margin and particularly in n I I it's it's still positive, but if you go back to the first quarter, revenue growth was high single digits. Now it's mid to

low single digits. Charles, maybe you could explain to people your perspective when it comes to the cycle of bank operating earnings and how they go through cycles at times of rising interest rates. Absolutely, you know, the theme I've had all year is that we are now investing for end of cycle dynamics, and when you enter that end of cycle period. What you want to look at is what is happening to the change in the rate of growth and and there are three key line items that

you're gonna want to pay attention to UM. One is revenues, the other is credit costs, and the third is capital return. And this year, what we're seeing is the revenue growth is decelerating. So we started high mid single digits in the first quarter, we're entering sort of mid single digits this quarter. We'll probably down to low single digits by the fourth quarter. And I think that's what we're going to see in in nineteen is low single digit revenue growth.

On the other hand, you're seeing credit costs, which are right now are very benign UM are likely to accelerate higher in nineteen UM. And then I think beyond that the capital return is going to slow dramatically. So the three variables are working against improving profitability. So I think we've seen peak profitability and that's what these stocks are starting to reflect. So one thing that I'm struck by is that JP Morgan posted its biggest loan growth in

a back to back period ever. Uh and this really edified initially anyway, people's feeling of strength at basically, even as interest rates rise, they're able to expand their loan book and they're able to capitalize the fact that interest rates are raising fast, rising faster than how much they have to pay depositors. Why does not not what does

that not give you confidence? Well, again, JP Morgan is one of the better in terms of execution, and they've been investing in their businesses and then showing some of the better, um you know, revenue growth. This I mean for this quarter, total revenues were up five percent year over a year, which is one of the better quarters that you're going to see. Um So, I have no problem with what JP Morgan reported. What I'm what I'm focused on is is that rate of change and growth.

And going back to your question about loans, they grew core loans around six this quarter, but they have been growing core loans at the upper single digit range earlier in the year. So it's that rate of change that's starting to show us flowing over what period of time, Charles, do you believe that the banks can turn their operations to be more nimble based on where they are in the cycle right now, because that would reflect decisions that are made now that only bear fruit six twelve months,

even twenty four months into the future, if not longer. Yeah, that's an excellent question, tim because because for example, PNC is getting punished today if the stock is down six dollars, and the reason is because they had sluggish loan growth in are only projecting low single digit revenue growth in the fourth quarter, and and they're falling behind the competition

and some of their momentum indicators. And they're claiming it's because they're trying to be prudent in this end of cycle where a lot of mistakes are made, but they're being punished for that because they're not showing the positive operating leverage that somebody else is to maybe taking more risk. Is I think at the end of the day, the banks will come out of this next down cycle whenever

it happens. I think it's going to happen in nineteen um the recession um with their balance sheets intact, with their capital intact, and they're going to be able to grow day one when we come out of that recession, and there's going to be a much bigger positive revaluation of these bank stalks out of that next cycle. But going into it, there's going to be skepticism that they haven't changed their historical practices, which is always to reach

for growth at the wrong time of the cycle. And that's going on, but it's going on more in the non bank system or the shadow market banking system than it is the banking system. Charles, is there any bank right now in the US that you think is a buy well? You know, I think we started a bear market and that the bank stocks will be down some thirty from their September I mean from their first quarter UM highs of eighteen, which I think is the peak. Is the top is now in place, and they'll be

down thirty by the depth of the recession. So within that cycle, call no, you don't want to buy banks. Can they outperform relatively? They could, but I'm not convinced that you get that change of secular leadership until you have that down in turn. On a trading basis, I've been advising my clients it's probably not no more than another five percent downside from where we are today, and so on a trading basis, maybe you want to pick

up a Wells Fargo or a city group. But you know, I'm talking about as a trader, because I still think that the cycle is for much bigger losses. Thank you very much for spending time with us as always interesting and insightful. Charles Peabody is the president of Portalis Partners. Speaking about bank earnings. We are broadcasting from the Bloomberg Interactive Broker's studios. I'm pim Fox along with my co

host and colleague, A Lisa Abramwitz. Just for an moment, imagine that you are in charge of a one hundred and fifty three year old company that started life in the pulp business, a paper mill in Finland, and after a series of reorganizations, it turns out that you have remade yourself in just twelve months. Here's what happened at Nokia. In April of the company completed the sale of its mobile phone handset business to Microsoft that accounted for more

than half of the company's sales. In April of Alcatel Lucent agreed to Nokia's sixteen point six billion dollar buyout offer. The deal closed in January. It has created the world's second biggest telecom equipment company. Hind Ericsson here to tell us about transformation is the chairman of Nokia. Resto Salisma He is the author of a new book entitled Transforming Nokia The Power of Paranoid Optimism to Lead through Colossal Change, and he joints us here in our studios. Thank you

very much, sir for being here. It's great to be here. Tell us why you decided to write this book. Well, I believe in learning. I'm an entrepreneur by background, and if you want to develop your company, every time you do something, you need to look back what worked out, what didn't work out, to create a culture of learning, so that people always sort of do a post mortem after they finished a project. And this is about learning.

It's about sharing the story of how to create a trusting environment, how to promote teamwork, how to promote openness, how to make bad news flow to the top quickly so that people can react to what is actually happening. We were sort of poisoned by the success of Nakia as a handset vendor, and that toxic side effect of success faces every single company that is hugely successful. And I think our lessons are worth sharing with other companies.

So what's the toxic side effect? Because at its peak, Nokia is the world's largest mobile handsup maker and cadet for about four of Finland's entire economic output. How is that a poisoning factor? Because when you're at the top of the world and everybody is telling you that you are the best thing ever, you start to believe that. And when you start to believe that, you become complacent.

You start paying more attention to external factors such as share price and what the analysts are writing, what the media says, rather than customers, got technology, employees, competition, and those small things accumulate and suddenly your competitiveness starts to disappear, but you may not notice because you're not paying attention to those crucial details anymore. You've been described as someone who has been motivated as much by maximum returns as

by soft values. Can you explain that a little bit? Well, Like many entrepreneurs, I believe that the long term is the the only real horizon. I don't follow daily share price movements at all. It may be two weeks between I pay attention to what the share price is. I want to build companies where employees really want to be proud of not only what the company achieves, but how they achieve That that how thing is so important, and

that's all about the long term. So perhaps you don't pay attention to the share price, but the shares have risen more than since you took over in two thousand and twelve the company, so I will say that it has done well. How do you foster that feeling though, of pride and belief in the company and its purpose, especially as its purpose changes. And there are certain core

elements that that remain and survive all changes. And for example, in Nokia, as we started rebuilding and transforming the company, we went back to our values from the nineties, which sort of resonated with people whose they they remember how in the nineties Nokia grew from being completely unknown to the top of the world. And it's it's that sentimental feeling that we are all humans aren't driven by feelings and emotions. It's not about fact only. Although I have

to wonder. I mean a big conglomerate, right, I mean a lot of conglomerates are facing a lot of issues because they have to kind of figure out what are they right and when we're seeing this with General Electric for example, So you know, belief and in faith, in a sense of pride or go so far, But what about the skills that you need to overhaul, etcetera. When you when you make a big shift, that's a that's

a good point. If you have a strong foundation of trust, which means openness, which needs means being ready for both bad news and good news, then you can experiment. People have the courage to try out new things even if they know they might fail, because they know that if I fail, nothing bad will happen. And when you experiment, you'll learn, and if you can do that at a

rapid cycle, then you'll survive the unpredictable changes in the environment. Now, you just went back to school in order to fulfill exactly some of these things. Explain what you're learning at school and why you decided to do this. Yeah, like many other leaders, I was challenging ins by machine learning

and what it can do. And like many others, I was told by my teams sort of what it means, and I learned those bullet points by heart, and like a paratte I went out and gave presentations on the power of machine learning without understanding the whole thing at all. And then I sort of woke up that this cannot be. I can't tell the world that machine learning will be the key component of our future competitiveness if I don't understand how it works. And then I went back to

school and I have studied programming again. I have taken six courses in machine learning programming and done so all sorts of architectures. And then I created a training program based on what I now understood and tried to create content that I would have wanted somebody to tell me when I was trying to figure out what does machine

learning mean for us? And this has been something of an inspiration to our R and D people, who I felt and come to me and said that I'm being a bit of shame that our chairman knows more about machine learning than I do. I'm not taking night courses on machine learning, and that's of course music to my ears. Let's let's sign up for this well, the power of shame, right if if if your fosters more about your job than you do, you start to feel like you gotta

catch up. Risto Celisma, thank you so much for being with us, and thank you congratulations on your book, Transforming Nokia The power of Paranoid Optimism to lead through colossal change. Resto Celis's chairman of Nokia also chairman and founder and former chief executive of f Secure Corporation. Here in our eleven three oh studios. Washington Post columnist and known critic

of Saudi Arabia disappeared mysteriously. Turkey is accusing uh Saudi Arabia of murdering the journalist in an alleged attack that was planned. Joining us now as Bobby got Ghosh. Bobby Ghosh is editor of Bloomberg Opinion based in London. Bobby, thank you so much for being with us. First, can you explain what we know at this point about this

situation and why it's so important. But we know that Jamal Kashogi about a week ago went into the Saudia consulate in Istanbul to collect some papers, um, and that was the last anybody saw or heard from him. Um. We know that the Turkish authorities have been leaking to the media, both local as well as international media, that they believed that they had evidence that Jamal Kashogi was first tortured and then murdered and then that his body

was removed from the Saudi consul. That they also have tracked the movements of a private aircraft with fifteen passengers that arrived that very day. They believe that these passengers included people who were responsible for the torture and murder. This is the extent off These are the facts that we know. UM. This is important because it is it comes while Saudi Arabia is trying to change its image

in the world. The crown Prince, the relatively new Crown Prince um moment Bin Salman, he's better known as MBS. He has been trying to change the way the country behaves. He has been trying to reform economy, trying to change many of the social regulations in the country, and trying to improve its image in the world. So this comes at a time this is this couldn't have been worse

type UM. This incident. If it is true that Jamal was killed in the Saudi consulate buy Saudi officials on the orders of senior Saudi figures in government, then this is not a new and improved Saudi Areia. This is very much an old one. In fact, in some ways it is worse than the old Saudi Arabia Bobby Ghost. This also has implications for the relations and ship between the United States and Saudi Arabia. Correct yes, name it does because Jamal was a resident of the United States

of Washington. UM. He was a columnist of Washington Post, well known in Washington political and diplomatic circles, were liked in those circles. UM. This is important because Saudi Arabia is very important to the Trump administration. Donald Trump's President Trump, his first international trip was to Saudi Arabia. UM. His son in law, Jared Kushner, has a close personal relationship with the Cown Prince. UM. The Trump administration has made a big deal of the fact that they're very close

to South Arabia. So anything that reflects poorly on South Arabia, especially since it involves an American resident, UM, he is going to there's going to be a splashback on the

Trump administration. Bobby, It's really interesting in light of the news that we have this morning with Turkey freeing in the detained pastor that President Trump and his administration have argued war, and it's interesting district contrast the rhetoric out of the Trump administration around that versus the rhetoric around this particular incident, and that basically President Trump seems to be taking a pretty hands off approach to this, saying yeah,

well you know who knows why. Argument This argument is that jama Kahoki is not an American citizen, whereas the pastor, of course he's an American citizen. Unfortunately, that argument won't wash because you know, States does have a responsibility for somebody who was legally resident in Washington. It has a responsibility because Saudi Arabia is a major ally, and it has a responsibility as the leader of the free world, as a beacon for for free speech and a free expression.

And Jamaica Shokei was essentially exercising his free speech. He was not I would I think we should point out he was not a strident opponent of the Soudi regime. He was very much a part of the South, the elite. His criticism had been quite mild. He supported the conference when the conference was appointed, he disagreed with some of the policies at the conference, then implemented and wrote about it.

That's the extent. This is not some left wing radical who's hiding out in the United States and taking pot shots at a regime. Is it possible that the United States will conduct an investigation and if it does and find something untoward, that there will be sanctions. Well, a number of senior senators in the US have pressed the presidents to do exactly that. Um Ran Paul the the Senator from Kentucky, is threatening to call a vote in the Senates to block all American arms sales to sell

the Arabia. He's run into tens hundreds of billions of dollars. Very senior American political figures are taking this seriously. Um The Trump administration might try to wriggle out of it, but if the if the Senators keep pressing and keep demanding answers, uh, then I think it'd be hard for

the White House to keep avoiding it. Bobby, just real quick here, there are a number of company leaders who have already said that they're not going to attend the so called Davos in the Desert event that is upcoming because of this incident. How significantly will that gain the attention of Saudi Arabian leadership. But this is a very very important, in fact, arguably even more than than NGOs or human rights organizations complaining about what happened to to Jamal.

This is going to make a much greater impact because a big part of the Crown Prince's reform agenda is to bring more foreign and private investment investment into the country. If major business leaders are backing out and don't want to be associated with this event, which is a sort of crown jewel of the of the program, that's a big deal. I want to thank you very much for

joining us. Bobby Ghosh is a Bloomberg opinion editor speaking about a Saudi Arabia Turkey and the disappearance of the journalist. Jamal also just mentioned that Bloomberg is a sponsor of the devas and we are monitoring this situation. This is Bloomberg here to tell us more about municipal markets as Amanda Alright, municipal bond reporter for Bloomberg. She joins us here in our Bloomberg Interactive Broker's studios. Amanda, thank you

very much for being with us. Before we get into sort a big picture, you know, trends and so on, I want to ask you about this really. I thought it was a very interesting story having to do with Los Angeles and what the city, what Los Angeles does with the revenue that it receives from parking finds from sales taxes. Explain what they do now and what might happen in the future. Sure. So. We had a really good story this week by reporter rom e Var Gazy

um So. She wrote about Los Angeles considering UM creating a public bank. UM. It would be the first U. S city to do so. Um So what that means is that it would move it's eleven billion portfolio UM from some of the biggest banks in the country to you know, self managed UM. It would invest in you know, local projects and kind of you know, seek to have more of like an E. S. G UM mindset rather than working with UM. Some banks that can come under controversy.

That's interesting. Why would they be doing this? Is it because of that environmental, social and governance issue or would there also be in a financial incentive. So the story talks a little bit about kind of how this effort UM you know, first started and so a lot of it was prompted by UM concerns about the Dakota Access pipeline UM and work with Wells Fargo a few years ago. Um So. Actually there was a big movement around public

banks UM during the Occupy Wall Street time. Um So it does sort of come from this E. S. G mind frame, and we do see Los Angeles being one of those cities that's you know, very much a leader when it comes to e s g UM issues, Amanda, I want to shift gears a little bit to what happened in the past week. There were some pretty big outflows I believe the biggest and more than a year from municipal bond funds in the United States. Why is

this just a rising rates kind of story. Yes, So the investors that I've spoken with, um, you know, one of them described it as simple bond math um. Basically, retail investors they start seeing the losses that munis have posted. UM, they see you know, the FED telegraphing more rates, and they get a little bit nervous about their holdings, and so they start pulling out of these funds. UM. It is something that investors keep a close eye on because

retail is so important to this market. UM. And you know, banks and insurance companies have kind of been on the sidelines after their taxes were cut earlier this year. UM. So these outflows are really really importan and we've seen them with mutual funds and we've also seen them with community ETFs. So what is going to be the likely consequence? I mean, at what point will this actually hamper or make it prohibitively expensive for municipalities to borrow money to

continue with projects they have planned. Or we're not anywhere close to that. I mean we're already seeing sort of the beginning stages of that. UM. The tenure benchmark from munis is at the highest since early UM. So that's pretty significant UM. And that obviously we're seeing, you know, deals that are coming in higher this year than they

were last year. UM. You know, issuers have kind of had these really low UM borrowing costs UM, and you know, we always wrote stories about how they didn't necessarily take advantage of those costs as much as they could UM. And so now they're kind of facing this prospect of rising interest rates for the foreseeable future. Does any of this have to do with the banks that no longer see municipal bonds as an attractive investment previous to the

tax reform? Absolutely so. UM. One really interesting dynamic is UM, the longer out you go on muni bond deals, the higher the yields are. And so if you look at where muni stand compared to treasuries, they're very cheap on the long end, but they're more expensive on the short end, which is where you know, retail kind of hangs out. UM. But because banks and insurance companies, you know, face this

lower tax rate, they haven't been buying munis as much. UM, So yields on the long end have already kind of risen up this year, whereas now we're seeing the short end kind of join in on on yield rising. I have to wonder, just going back to what him was talking about with this Los Angeles Public Bank, would that replace municipal debt as a form of financing. Would they

have to borrow in the muni market? I ask this because as rates rise, I have to wonder what alternative methods municipalities are going to look to possibly finance themselves. I think that's a great point, um. And also the opportunity zones that we saw come out of the tax reform Act, Um, municipalities are going to have to get

creative with how they finance projects within their own orders. UM. You know, the Los Angeles Bank, you know, there's a lot to be determined their you know, voters have to approve it first of all. UM, And there are still some questions about the costs of creating such a bank. So Muni's might still end up being the more cost effective option. As far as this creates this potential bank, would that be something that would have to have like a federal charter a state charter? Is there any precedent

for this? Do we know there is a state bank out of North Dakota. UM, so it's not federally regulated, which is interesting. UM. But obviously Los Angeles is very very big, UM. You know, being the first to get involved with something like this, UM, you're gonna invite a lot of scrutiny not only from maybe regulators, but also um from residents living in that city and wanting to make sure funds are used appropriately and and matters like that. Amanda, alright,

really really great stuff. Thank you so much for joining us. We really appreciate it. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa abramowits one before the podcast. You can always catch us worldwide on Bluebirg Radio.