What this Bank’s Financial Statement Tells Us About the Economy

Dear Readers,  

At times, it may seem as if my Letters only show the ugly side of the world.

From the increasing tensions headlined by world super powers, to the economic distress within our own borders, there are much bigger forces at work.

While instilling confidence may appear to be a good strategy in times of concern, false confidence only leads to bigger disasters.

And that is what is going on here in the Western world.

The stock market’s rise has propped up society’s morale, but economic conditions continue to deteriorate as the middle class continues to shrink.

Over the past years, I have continued to show confidence in the stock market; not based on growth fundamentals, but rather the liquidity of money that has been fueling the markets.

In addition, I talked about how large corporate stock buybacks were continuing to take place while cash was being spent on the growth of stocks and not on capital investment.

Just this week, Cisco, the world’s largest networking equipment maker, announced it would be slashing another 6000 jobs to save $700 million.

That’s roughly 8% of its workforce.

Cisco made around $10 billion in profit in the last fiscal year and managed to buy back nearly $3 billion in stock, while paying out even more than that in dividends.

Since 2011, the Company has fired around 21,000 employees, and used the cost-cutting measures to buy back nearly $22 billion worth of its own stock.

Here’s what happens when you cut the workforce, buy stock, and hand out dividends:

So yes, corporate profits are strong and has resulted in higher share prices and big bonuses for the guys at the top. But for the little guys, the true economic drivers, things aren’t so great.

What The?!?

The stock market has historically been – and should be – a forward-looking indicator of the economy.

Yet, we all know that’s not the case when the Fed is in charge.

Here’s the first paragraph of a headline article I read this week on Bloomberg, one of the world’s largest financial news agencies:

“U.S. stocks rose, pushing the Standard & Poor’s 500 Index to a two-week high, as a slowdown in retail sales boosted speculation the Federal Reserve won’t be forced to raise rates sooner than anticipated.”

That sums up our market: If retail sales suck, stocks will rise; not because the economy is doing well, but because the Fed won’t raise rates.

Another great opening piece from a Company that makes a living selling news to financial outlets…

Oh, SNAP!

From schools to large corporations, layoffs have risen every year.

U.S. tech company job cuts have already gone up by 68% in the first half of 2014, leading to what could be the most tech layoffs since 2009, according to a report released Monday by Challenger, Gray & Christmas.

With Cisco and Microsoft’s big layoffs announced earlier this month, tech job losses this year will exceed last year’s.

Companies from every sector (aside from oil and gas) including Rogers and Jon Deere, have announced more major job cuts.

How is it possible that unemployment continues to decline, yet there have been mass layoffs at practically every major corporation?

I have already explained that part of this reason is the declining workforce, that is declining at a rate that’s faster than jobs are being created.

Simply put, unemployment only counts those who are still actively looking for a job.

But let’s say that doesn’t matter.

Let’s say those who left the workforce left because they don’t need jobs anymore (who needs them anyway?).

Let’s say that since the unemployment rate is now nearly back to pre-2008 levels, the economy is much better and we should all just sit back and relax.

Or should we?

Let’s ask the guys over at the Supplemental Nutrition Assistance Program (SNAP).

Otherwise known as food stamps, enrollment in the program is now higher in every state than it was five years ago, even though unemployment has dropped in every state during the same period.

The size of the SNAP program — both in dollars and the amount of over-payments — has more than doubled since 2008, from $34.6 billion to over $76 billion in 2013.

Of course, food stamps aren’t the only thing that continues to rise. Every form of government handouts continue to rise as well.

Remember the chart I showed you from last year showing the mass increase in government handouts?

Guess what? It’s still rising…

I guess this is just one example of how well the US economy is doing.

But wait, there’s more.

Do you think the US economy getting better?

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Banking Back to Normal 

According to the WSJ, since bank profits are rising, it must mean that banks are now lending again:

 “Banks are lending to companies and individuals at the fastest pace since the financial crisis, helping propel profits to near-record levels.

…U.S. banks posted $40.24 billion in net income during the second quarter, the industry’s second-highest profit total in at least 23 years, according to data from research firm SNL Financial. The latest profits are just below the record $40.36 billion recorded in the first quarter of 2013.”

TIME confirmed this as well:

“The other reason to feel relatively good about rising bank profits has to do with how banks are making that money. Monday’s Journal story emphasized that the jump in bank profits was tied to increased lending levels; commercial lending rose at an annualized 13% rate, while consumer lending climbed 6%.”

And lending is good for the economy:

“…That’s good news because lending is what we – even those among us who resent bankers – want banks to do. Lending helps businesses grow and helps consumers buy stuff, both of which ultimately help the overall economy. In fact the anti-banking crowd has been complaining that banks haven’t been doing enough lending. So they should take heart that that’s starting to change, even if it means banks are earning enviable profits in the process.”

Yes, it’s true: If banks begin to lend to smaller businesses, then an economic recovery might be more viable.

But is this really the case? Are banks actually lending more?

Although some of the world’s largest and most respected media outlets have found a way to spin higher bank profits as a sign of economic recovery because more loans are being made, don’t be so quick to believe it.

Let’s take a closer look at the Bank of America, one of the world’s largest retail banks and the second largest bank holdings company in the US, to see if, indeed, record loans were the cause of the rise in bank profits.

A Look at the Bank of America

According to the Bank of America’s latest financial statement, both loans and interest income from loans have actually decreased – not increased:

Looks to me like loans weren’t the primary reason for higher bank profits, as the Wall Street Journal suggested.

So where did all the big bank profits come from?

Let’s take a closer look at the balance sheet highlights:

Bank of America Highlights

• Global Wealth and Investment Management Reports
  Record Revenue of $4.6 Billion and Record Total Client Balances of $2.47 Trillion.
• Asset management fees grew to a record $1.95 billion, up 15 percent from the year-ago quarter.
• BAML ranked among the top three financial institutions globally in leveraged loans, convertible debt, asset-backed securities, common stock underwriting, investment grade corporate debt and syndicated loans during the second quarter of 2014(H).
• Fixed Income, Currency and Commodities (FICC) sales and trading revenue, excluding net DVA(B), increased 5 percent from the second quarter of 2013 to $2.4 billion.
• Global Markets reported net income of $1.1 billion in the second quarter of 2014, up 14 percent from the year-ago quarter. Revenue increased $389 million, or 9 percent, from the year-ago quarter to $4.6 billion, reflecting higher equity investment gains (not included in sales and trading) and increased investment banking fees.
• Global Banking reported net income of $1.4 billion in the second quarter of 2014, compared to $1.3 billion in the year-ago quarter.
• Global Corporate Banking revenue increased to $1.6 billion in the second quarter of 2014, up $29 million from the year-ago quarter, and Global Commercial Banking revenue decreased $59 million to $1.7 billion. Included in these results are Business Lending revenue of $1.8 billion, down $80 million from the year-ago quarter.
• Global Transaction Services revenue of $1.5 billion, up $50 million from the year-ago period.
• Global Banking investment banking fees, excluding self-led deals, increased $33 million versus the year-ago quarter.
• Fixed Income, Currency and Commodities (FICC) sales and trading revenue, excluding net DVA(B), increased 5 percent from the second quarter of 2013 to $2.4 billion.

Looks to me like a lot of income was generated through things other than loans to consumers and small businesses, with business lending revenue down from the year-ago quarter.

Do you still believe the headlines that banks are lending more? Are they lending more where you live?

The Housing Market

A bank’s income statement can also be a great sign of what’s happening in the economy. In particular, it’s gives us a glimpse into one of the strongest segments of any economic recovery: the housing market.

So just how did Bank of America do in that department?

• Consumer Real Estate Services reported a net loss of $2.8 billion for the second quarter of 2014, compared to a net loss of $930 million for the same period in 2013, driven largely by a $3.6 billion increase in litigation expense.
• Revenue declined $725 million from the second quarter of 2013 to $1.4 billion, driven primarily by lower core production revenue due to fewer loan originations as well as lower servicing income, primarily due to a smaller servicing portfolio.
• CRES first-mortgage originations declined 59 percent in the second quarter of 2014 compared to the same period in 2013, reflecting a decline in overall market demand for refinance mortgages.
• Core production revenue decreased $542 million from the year-ago quarter to $318 million due primarily to lower volume and a reduction in revenues from sales of loans that had returned to performing status.

Contrary to the Wall Street Journal’s headline article, it seems we’re actually seeing less activity in loans across the board (at least with America’s largest retail bank).

But there is good news…not all loans are suffering:

“Credit card issuance remained strong with the company issuing 1.1 million new credit cards in the second quarter of 2014, up 18 percent from the year-ago quarter.”

It’s amazing how journalists can create headlines that may have nothing to do with the truth. It’s even more amazing that when bankers are interviewed regarding those headlines, they just accept them as fact.

Look, I want to believe things are getting better. But that would mean believing in lies, or half-truths.

If things were getting better, you would expect the smart money – the richest 0.0001% (how many zeros should I add?) – would be doubling down on the economy.

But they’re not.

Where’s the Smart Money Going?

According to the SEC filings, George Soros – the man who made a fortune betting against the market – is once again doubling down on its demise.

Soros has now increased his total SPY put* to a new high of $2.2 billion. That’s nearly double his previous all time high.

*A put becomes more valuable as the price of the underlying stock depreciates relative to the strike price.

Of course, we can’t be sure what he has done with that position since the filing.

But he’s not the only billionaire investor that’s beginning to change his sentiment.

Carl Icahn, another multi-billionaire investor, wrote in a recent op-ed that we are, in fact, “in a major asset bubble that continues to grow.”

Do you believe we’re in a major asset bubble?

Be Weary of the Nikkei

But now that the BOJ has stepped in, we should be a little more weary of the profits that have been made leading up to the BOJ’s stock purchases:

Via WSJ:

“Through a trustee, the (Bank of Japan) purchased a combined ¥92.4 billion ($904.2 million) in ETFs over the first six business days of August. That’s the BOJ’s longest and largest consecutive buying streak since it started purchasing ETFs in December 2010.”

The BOJ has said it plans to increase its ETF holdings to ¥3.5 trillion by the end of this year. As of Aug. 10, it held ¥3.122 trillion.

This means the BOJ’s market support could soon end. If it does, shares could drop.

That is, unless, the central bank announces further purchases…

The Takeaway

1. The economy is doing great because more jobs are being cut, people are leaving the workforce, and unemployment is going down.
2. If retail sales slip, look for stocks to rise – c/o Bloomberg.
3. Banks are making record profits, which means they’re lending again. That means things are getting better – c/o The Wall Street Journal.
4. Don’t believe everything you read.

“Any dictator would admire the uniformity and obedience of the U.S. media.” – Noam Chomsky