“It was the best of times. It was the worst of times.”  A Tale of Two Cities; Charles Dickens

In recent months, I have opined on the sometimes-conflicting economic signals that the Market (and the Fed) have been trying to decipher in accurately forecasting what lies down the road. A decade long economic expansion that appears to still have some legs. A recent inversion of the yield curve, as measured by the yields on the 2-year and 10-year Treasury Notes, has historically been an accurate indicator of a looming recession. Consumer sentiment remains robust amidst geopolitical turmoil and the general unsettled nature that seems to be accompanying the run-up to this year’s general election. The manufacturing sector contracting for five consecutive months, raising concerns of potential contagion on the retail front, before it most recently reversed course with an expansionary reading of the touted ISM manufacturing metric. Collectively, a sense of both solace and caution, as it relates to the economy, is completely understandable, albeit complicated.

The opening lines of Charles Dickens’ classic novel, A Tale of Two Cities, seemed apropos. Particularly in light of the daily bombardment of cable news networks coupled with the onslaught of political advertising that, at times, seems to paint two distinctly different pictures of the existing economic landscape and expectations for the near future. The phrase “self-fulfilling prophecy” continues to garner attention, as some financial experts opine that we may be at risk of talking ourselves into a recession, irrespective of current economic indicators.

Consequently, in the category of “a picture is worth a thousand words”, I believe a chart that recently appeared in a financial article accurately illustrates the competing views of current economic dynamics. The graphic reflects the general underlying strength of the equity markets in recent years, as depicted by the more than 30% return in the S&P 500 since year-end 2017, juxtaposed against a steady decline in “CEO optimism” that succinctly captures corporate sentiment that, while still leaning toward continued economic expansion, clearly demonstrates that the once fervent ardor of that tone is now abating:

Mixed Economic Sentiment
Growing Gulf Between Investors and Corporate Leaders

Inflation is tame, by all measures. Unemployment rates continue to trend at 50-year lows. However, there are emerging headwinds that give all of us pause. Weaker global growth (most recently in China and Germany), uncertainty surrounding the ramifications of Brexit, a sharp increase in market volatility that began in late 2018 (although muted for much of 2019, before re-emerging of late), continued unknowns in terms of the potential implications of trade tariffs, possible shifts in the Fed’s balance sheet as it gauges economic stability, an annual budget deficit hovering north of $1 trillion, which would feed an already $23+ trillion level of Federal debt, negative yields in Europe, and, most recently, the unknown economic ripple effects of the coronavirus, to name just a few.

On the banking front, significant anecdotal commentary across the industry in recent months is slowly morphing into empirical evidence with regard to some of the headwinds facing the financial sector. Fed rate cuts through last Summer have translated into heightened margin pressure, as many organizations reported year-over-year and linked-quarter contraction in their NIMs while signaling preliminary expectations of continued compression as they move through 2020. For many of the larger organizations that enjoy research coverage in the investor community, initial earnings forecasts for this year are typically showing anemic (if any) growth year-over year. As I touched on recently, in some cases I am actually seeing ’20 EPS expectations below 2019 actuals. I believe, in part, this helps explain muted, and seemingly cautious, trading activity in some corners as the absence of robust core earnings growth has stagnated potential multiple expansion within the banking universe. Credit costs (particularly for larger organizations now required to implement CECL) could prove volatile, and assuredly will be de facto proxies for the assumed comparable impact at smaller organizations that are currently “CECL-free” for the next few years. Add to all of this the uncertainty that is likely to accompany continuing trade tensions and an ever-tightening labor market that may finally trigger inflationary pressures.

Interestingly, a little over a year ago the markets were moving with the expectations of continued rate increases at the Fed through 2019 and probably into 2020. However, at the start of 2019, sentiment shifted in a meaningful way as the Fed communicated it would be “patient” and “data dependent”, thus putting its intended methodical tightening program on hold. And, as we moved through the summer, Fed policy was dramatically altered yet again with three quarter-point rate cuts and somewhat mixed signals with regard to the possibility of additional easing. Nearly two months into 2020, the consensus opinion remains steadfast that we are unlikely to see a shift in monetary policy as the economy continues to grow, even if at a more modest pace.

However, we still operate in a risk-assessment business. As emphasized in past writings, maintain underwriting integrity and discipline. Manage capital and reserves carefully. Emphasize sound risk management practices and a robust architecture. You are stewards of your shareholders’ investment. The constant, for successful banks, has been adhering to solid credit standards and sound cost controls. Whatever is on the other side will, inevitably, pass. Do what you need to do so that when it does, you are still standing.

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 2020.