Will Fairy Tales and Unicorns Destroy JP Morgan’s Winning Streak?

Jamie Dimon, chairman and CEO of JP Morgan Chase, at the JPMorgan Healthcare Investment Conference. Photo by: Steve Jurvetson. Wiki Commons License. Used with permission.

It has been a year rife with IPO losses, with the We Co. (WeWork) on the ropes, Uber losing $5.2 billion in the 2nd quarter of 2019 and Lyft shares down over 50% since its first day of trading. How much of that will impact the banks this earnings season? We’ll know by 7 am, when JP Morgan releases its 3rd quarter 2019 earnings report.  
 
Looking at bank fundamentals and analyst ratings (Buy buy buy!), one might be enticed to lean in for more financials exposure. The price to earnings ratios look fair, between 8 and 15. The profit margins range from 18% (Goldman Sachs and Morgan Stanley) to 31% (JP Morgan and Bank of America). Sales growth is holding steady, even though many of the banks have virtually stopped lending to homeowners, due to the low margins. As Jamie Dimon, the chairman & Chief Executive Officer of JPMorgan Chase & Co. explained in the company’s 2nd quarter 2019 earnings call, “It simply does not make sense to own home mortgages when you're constrained by standardized and you can't securitize.”
 
However, past earnings are like looking in the rearview mirror. When driving for gains, it’s a better idea to polish up the crystal ball and look out on the horizon.
 
The WeWork IPO Implosion
Morgan Stanley should be clear of this one, having exited the fray when they were denied the lead on the IPO. However, sources, including The New York Times and the Financial Times, peg loss exposure in the hundreds of millions on both Goldman Sachs and JP Morgan. SoftBank reportedly has at least $11 billion in equity investments in the We Co. JP Morgan is believed to have loaned former CEO Adam Nauman hundreds of millions personally against his equity ownership in the company.
 
When a company’s value gets written down to $10 billion from $47 billion, wiping out 79% of the assumptions every pre-IPO investor was banking on, that’s going to scar an earnings report. In fairness, we just don’t know the We Co.’s value at this time. However, investors balked at buying in for even a $15 billion valuation. And Fitch downgraded WeWork’s credit rating to CCC+ this month after the IPO was pulled, putting the company’s bonds firmly in junk-bond territory.
 
According to The New York Times, there are two competing plans to take over the company, one from SoftBank and one from JP Morgan. Meanwhile the We Co. lays on the ropes in a cash-crunch coma.
 
One of the fundamental toxins in the We Co. business plan is that the company signs on for long-term leases, while accepting short-term contracts with its customers. Another poison was not having a clear path to profitability, and being astonishingly steeped in nepotism and hubris, while short on business acumen. The We Co. lost $905 million in the first six months of this year.
 
Since the IPO was pulled on September 30, 2019, the last day of the third quarter, the full financial accounting of the We Co. debacle is more likely to play out in the months ahead. It’s also possible that the company will want to rip the band-aid off and just put it behind them. However, that’s more likely to happen in the 4th quarter 2019 earnings than in tomorrow’s report. Another negative omen is that there have been other IPOs that sank in share price upon hitting the big boards this year, including Uber and Lyft. Any pre-IPO bank investments will have to be written down at some point, which may impact earnings.

The Poor Performing IPO Class of 2019, combined with a flat yield curve and the overnight stress in the repo lending market are all signs that there is more going on behind the scenes in the financial industry than is being fully accounted for in the earnings reports and headlines. Will this quarter’s earnings reveal more weakness than investors are anticipating? Are financial storms on the horizon? Tomorrow will tell, as will the advance report of U.S. 3rd quarter GDP growth, which will be released on Oct. 30, 2019.
 
3rd Quarter 2019 GDP Growth
With the full year 2019 GDP growth expected to be restrained to 2.2%, many economists are expecting a weak showing on Oct. 30, 2019.

Banks have been the most aggressive buyers of their own stock. So, it’s not a great idea to bet against these juggernauts. JP Morgan repurchased $5 billion shares of its own stock in the 2nd quarter of 2019, with a total of $7.5 billion returned to shareholders in stock repurchases and dividends.
 
However, it’s clear that institutional investors are sobering up and demanding profitability and reasonable valuations. The WeWork IPO and other financial hits will have to be accounted for. If not in the 3Q 2019 earnings season, then perhaps beginning as early as Christmas.
 
Remember last Christmas was the worst December in stocks since the Depression. The S&P500 dropped 9.2%. That phenomenon was pegged to Apple pulling back on its astonishingly aggressive buyback pace. Apple cut its repurchases by half in the 4Q 2018, to $10 billion, from an average $21.4 billion in the three quarters preceding that.
 
JP Morgan and Wells Fargo both increased their share buybacks in the last quarter of 2018. However, that wasn’t enough to save the day last December.
 
The Late Stage of the Business Cycle
This kind of race to monetize and capitalize cash-negative “unicorn” IPOs is a hallmark of the late stage of the business cycle. Inverted yield curves are 100% associated with recessions over the last half century. So, now is the time to stop looking back at how far this bull market has come, and start battening down the hatches to prepare for rougher seas to come.



 
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