There is an old Wall Street saying that “Bull Markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” Clearly market volatility has picked up in recent months, as competing sentiments regarding uncertainty over global trade tensions and the potential implications of a chaotic Brexit duel with continued low unemployment levels and solid GDP growth. A few months ago, it seemed a virtual certainty that the Fed would increase interest rates at least two times, if not three or more, during the course of 2019. Today, the central bank has signaled a more measured tone with regard to possible rate increases, with expectations now reflecting maybe one (possibly none), in 2019 as the Fed indicates it will be more “data dependent” and “patient” in the face of developing trends.
This is not meant to imply that Armageddon is somewhere around the corner. Actually, there is probably still a bit of runway left in this economic expansion before it comes in for a (hopefully soft) landing. The U.S. bull market eclipsed 10 years earlier this month, with the S&P 500 having climbed more than 300% since its Financial Crisis-low recorded on March 9, 2009. Soon thereafter marked the start of the current economic expansion, beginning in the summer of 2009, and if it continues through this July, it will stand as the longest expansion since World War II, eclipsing the 120-month-long economic expansion recorded between 1991 and 2001. And it should be noted, in the annual “Economic Report of the President,” the White House is forecasting 3.2% and 3.1% GDP growth for 2019 and 2020, respectively. In 2018, the U.S. economy grew at a rate of 2.8%, fueled in part by tax reform, regulatory relief, continued low unemployment and any building inflationary pressures that appear to remain in check.
To my knowledge, no one has yet created the crystal ball that clearly and accurately predicts the timing and magnitude of U.S. economic recessions. As I have opined in recent months, one of the historically best early indicators, an inversion of the yield curve, continues to reflect a precipitously narrow 15-20 basis point spread between the short- and long-ends, but not yet inverted. An added complexity to that picture lies in the form of the Fed’s to-date carefully controlled unwinding of its massive $4+ trillion balance sheet as the central bank focuses on the eventual size and composition of its holdings in today’s economy.
On the banking front, management teams continue to monitor closely the prognosis of an eventual economic slowdown, while gauging the implications of rising deposit prices (and resultant margin pressures, if market rates remain relatively static) and the ever-present cyber-security threats and challenges the industry faces. This continues to reinforce our mantra to drive and cultivate a sound risk management culture across all levels of your organization. You are stewards of your shareholders’ investment in your institutions, and a solid governance framework continues to reflect sound practice. Effective communication and the ability to pro actively address looming and/or developing risks will always be rewarded.
Which brings us to the title of this piece, “The Noah Principle.” It has been attributable to many business leaders over the years, including legendary investor, Warren Buffett. But I remember first hearing of its application when reading about IBM Corporation. Louis Gerstner, who earlier in his career had been a high-ranking executive at American Express before taking the Chairman and CEO reins of RJR Nabisco, was recruited to IBM in an effort to lead a massive turnaround of its declining fortunes in the early 1990s. As the story goes, while listening to a seemingly never-ending litany of IBM’s problems from staff across the company, he is said to have finally and simply stated “Enough. No more prizes for predicting rain. Time to start building arks.”
There are emerging headwinds, as mentioned earlier, that give us pause. Weaker global growth, uncertainty surrounding Brexit, a sharp increase in market volatility in late 2018, unknowns in terms of the potential implications of trade tariffs and shifts in the Fed’s balance sheet, an annual budget deficit approaching $1 trillion which would feed an already $20+ trillion level of federal debt, and a continuing sense of political dysfunction on both sides of the aisle leading up to the 2020 election, to name a few. Obviously, all legitimately give cause to growing skepticism. However, one cannot lose sight of historically low unemployment levels and solid job creation, inflationary pressures that appear to be under the Fed’s 2% target, and continued strong economic growth that in most corners is expected to continue well into 2020. And with the Senate still in Republican control, there appears to be no imminent threat of policy changes that could alter the existing broad support for further economic expansion and market gains. Couple this with the recent significant, and meaningful, shift in tone from the Fed regarding future interest rate moves, which confirmed that near-term monetary policy will not simply be placed on auto-pilot as critical economic data is absorbed and digested.
We are all compensated for taking risk. Ideally, that pursuit is conducted in a prudent and pragmatic manner, because we have all witnessed the devastating effects when an organization gets out a little too far over its skis on the credit and operational spectrum. Economic cycles have not been repealed. A slowdown, at some point, is inevitable, although it does not appear to be imminent. Remember, expansions don’t die of old age. Reinforce sound risk management practices across the organization. No more prizes for predicting rain – make sure capital levels remain robust, reserves are strong, underwriting standards are not being compromised, business practices are solid — they are all effectively “arks.” Continue to build them.
In closing, attached please find our monthly summary of Michigan’s financial institutions. As you and your Board take your organization forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of any assistance in helping you assess the competitive landscape. My best wishes for continued success as you move through 2019.
MARCH 2019 MICHIGAN BANKING SUMMARY
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