Banking on Profits: Market Update
Market Concerns and Treasury Yields
The financial landscape is presenting some interesting challenges, especially when it comes to Treasury yields. While there’s widespread worry about yields reaching the 5% mark, there is a more substantial concern regarding the potential of them climbing to 7% or even 8%. This scenario could easily come to fruition due to factors like confusion surrounding tariffs and the potential impacts of suspending legal immigration. Such developments might lead to an inflation spike of 5-7%, potentially pushing the 10-year Treasury yields to those risky levels, which would be highly detrimental to the market.
Personally, I avoid shorting the market, preferring to steer clear of certain sectors and hedge instead. It’s often risky to short really overvalued assets, as the popular stocks can unexpectedly surge, leaving you in a vulnerable position.
The Potential Lost Decade
Looking towards the future, various indicators—conditions, valuations, sentiment—suggest we might be entering a period similar to the “lost decades” experienced from 1968 to 1982 or 2000 to 2010. These periods followed exceptionally bullish markets, and it’s important to note we’ve seen similar bullish trends since March 2009, driven by fiscal and monetary policies.
What Worked in Past Difficult Markets
During challenging times in the past, thrifts performed exceptionally well. In the period from ’68 through ’82, investing in these entities at low prices proved to be a very successful strategy. In Warren Buffett’s 1984 “The Superinvestors of Graham-and-Doddsville” speech, he highlighted the success of investors who adhered to Ben Graham’s value investing principles. These investors, including Walter Schloss and the partners at Tweedy Brown, focused on financially sound companies, purchasing them at significant discounts to their tangible book value or earning power. This strategy was highly rewarding during both the ’68-’82 and 2000-2010 periods, especially amidst industry consolidation.
Real estate also showed strong performance in both periods, with significant gains seen following market dips. Investing in real estate during the 2000 market crash, for example, turned out to be like money in the bank.
Current Market Conditions
The market is currently trading at a high multiple of 30 times earnings with a CAPE ratio of 38. Projected earnings growth relies heavily on AI advancements delivering flawlessly and interest rates declining.
The market hasn’t fully adjusted to the interest rate increase from 0.25% to 5.5%. While there’s been a 100 basis point reduction, this decrease doesn’t entirely justify the valuations seen in venture capital, private equity, or broader market assessments.
Recent job reports reflected the existing market psychology, showing good news with the addition of 256,000 jobs, perfect for a healthy economy, with 4.1% unemployment. Despite sectors like healthcare, retail, and government leading the gains, the market saw a collapse with a concerning number of new lows.
The Real Economy
Contrary to political claims of a weakened economy, people continue shopping, traveling, and enjoying entertainment. However, inflation fatigue is prevalent as consumers are tired of rising prices on everyday items.
There’s been robust container traffic into Los Angeles and a resolution of East Coast port strikes. Despite alarming headlines, consumer spending remains healthy, not just on necessities but on discretionary items, and the jobs market shows few layoffs with below-historical-norm loan delinquencies.
Federal Reserve Policy
The Federal Reserve’s recent meeting minutes revealed a significant debate around interest rate cuts. While political factors influenced decisions on rate changes, strong economic indicators suggest the economy might not have required such aggressive action.
Banking Sector News
In regulatory news, Michael Barr’s resignation as vice chair of regulation at the Federal Reserve is perceived positively for the banking sector. His previous regulatory approach, though targeting larger institutions, affected smaller banks as well. His continuation as a governor, however, softens the impact. A potential appointment of Michelle Bowman could strengthen the sector, given her community banking background.
ESSA Bank Merger
ESSA Bank’s merger with CNB Financial in an all-stock deal valued at $21.10 is notable. Investors following prior advice to purchase during volatile times have seen substantial benefits, enjoying a performance well above market averages. The recent banking crisis offered further advantageous buying opportunities resulting in significant gains.
ESSA’s strategies post-thrift conversion have consistently expanded towards key areas, with CNB being a solid acquisition, trading currently at 9 times earnings and at 97% of book value. The merger is expected to yield significant cost savings and expand geographic reach.
Texas Community Bank (TCBS)
There has been notable insider buying at Texas Community Bank this week, highlighting an intriguing story tracing back to its founding in 1934. The bank remains committed to a conservative approach—taking secure deposits and issuing home loans. The area’s development into a retirement and commuter community for Dallas adds to its appeal.
Board composition reflects classic community banking values, incorporating a diverse mix of local professionals. Change of control restrictions have expired, opening up potential acquisition discussions, making this well-capitalized bank a potential target for larger players.
Looking Ahead
We continue to have high hopes for small banks while maintaining a cautious stance on the broader market, especially regarding big tech and interest rates. Adhering to principles of margin of safety, valuation, credit quality, and avoiding imprudent bank actions remains our strategic focus. Though less liquid and efficient, sticking to our principles during volatile times often creates lucrative buying opportunities.
Keeping abreast of market dynamics, regulatory changes, and economic indicators will be crucial in navigating this complex financial environment.
