Armageddon Forecast: Fed Releases 2017 “Adverse Scenario” Report
Let’s address a very specific, downright apocalyptic economic scenario today.
Just please don’t call it a “forecast.”
I’ll tell you why in a moment.
First off, prepare for the following three major shifts in the global economy…
Shift #1: Be ready for higher long-term interest rates…
Shift #2: A steeper yield curve, and…
Shift #3: Regionally concentrated episodes of deflation — more pronounced in Japan, less severe in the euro area and developing Asia and absent in the United Kingdom and United States.
How can I be so specific?
It’s simple, really.
The Federal Reserve just released its “Adverse Scenario” for 2017 upon which major U.S. banks will be stress-tested against.
The three above-mentioned shifts are brand-new inclusions into this year’s “scenario.” Just don’t call it a “forecast,” says the Fed.
Below, I’ve summarized the Fed’s apocalyptic scenario for you… that is, according its new report:
- The level of U.S. real GDP begins to decline in the first quarter of 2017 and reaches a trough in the second quarter of 2018 that is about 6.5% below the pre-recession peak
- The unemployment rate increases by about 5.25%, to 10%, by the third quarter of 2018
- Short-term Treasury rates fall and remain near zero through the end of the scenario period
- Financial conditions in corporate and real estate lending markets are stressed severely
- Equity prices fall by 50% through the end of 2017, accompanied by a surge in equity market volatility, which approaches the levels attained in 2008
- House prices and commercial real estate prices also experience large declines, with house prices and commercial real estate prices falling by 25% and 35%, respectively, through the first quarter of 2019
- Severe recessions hit in the euro area, the United Kingdom and Japan — and a marked growth slowdown in developing Asia
- All foreign economies included in the scenario experience a decline in consumer prices
- The U.S. dollar appreciates against the euro, the pound sterling and the currencies of developing Asia — but depreciates modestly against the yen because of flight-to-safety capital flows.
I tend to favor Martin Hutchinson’s Armageddon scenario.
If you missed Hutch handicap the odds of a global economic collapse, and how to protect yourself, be sure to check it out.
Today, on the heels of the Fed’s new report, I asked Hutch to drill down into the banking sector.
Is it possible that a few bullish opportunities exist?
The details are below.
Chief Investment Strategist, Wall Street Daily
Question: Martin, what’s something that’s flying under the radar? Sometimes these are the best opportunities, the ones that the media haven’t picked up and are just completely going unnoticed by the press. What’s going on in your world?
Martin Hutchinson: Well, I’d like to talk about regional banks this week because there’s a number of winds that are blowing very much in their direction. I think they look attractive.
Question: Let’s do it then. Where did you want to start?
Martin Hutchinson: Firstly, you’ve got interest rates rising. That’s very good for banks with retail customers. Because retail customers tend to have checking accounts with zero interest on them — or very low interest. If rates rise, the bank’s spreads rise because they make more on their lending.
Secondly, the economy is stronger. That’s good for loan generation. Thirdly, lower corporate tax rates. That’s important because the smaller corporations that regional banks deal with actually pay full corporate tax, not like the GEs of this world.
Therefore, lower tax rates really help them do more business and generate more loan volume.
Then there’s deregulation, which will help the regionals more than the too-big-to-fails. That’s because it’ll reduce the huge reporting and compliance burden that’s been imposed on regional banks. The independent bankers have been complaining about this for the last few years.
Finally, there’s the statistic that I think is very interesting: New bank formation has only gone up one per year since 2010 — versus an average of 130 per year before 2007.
Question: Why such a slowdown, Martin?
Martin Hutchinson: I think it’s largely regulations. It’s also that banking isn’t very profitable with zero interest rates. So as we’re getting away from zero interest rates, that’ll improve it. Since 2,000 banks have disappeared since 2010, it also means that on the smaller end of the banking business the competition’s got less fierce.
That’s given some opportunities for midsize and smaller regional banks.
Question: Let’s talk about those opportunities. What are you seeing?
Martin Hutchinson: They’re less exposed to investment banking and derivatives than the big guys. Also, surprisingly less leveraged, which is a very good thing if you want them to be stable. You can pick your favorite region where there’s some decent economic growth.
One region I particularly like is the Dallas Metro area, which is Texas’ main banking center historically. All the biggest banks there went bust in the late ’80s and got bought up by New York banks. The result is you had a bunch of people running banks around Texas — the branches didn’t disappear. These people were from 1,000 miles away and didn’t understand the local market.
Dallas real estate was a quiet market until 2000 — and never really suffered in the 2007–08 downturn, because it hadn’t gone up much. It’s now pretty strong, and that means there are real loan generation possibilities for a Dallas bank. Of course, Texas in general is a business-friendly state with decent growth.
Question: Cool, so we know we like regional banks. If we’re going to home in on an area, it really sounds like you’re bullish on Dallas/Fort Worth. What should we do with this information, Martin?
Martin Hutchinson: I’ve got a particular bank that I like, which is Independent Bank Group (IBTX). It’s a $6 billion bank with 42 branches in Dallas/Fort Worth, Austin and Houston. Its debt equity is 8, or 12 if you look at tangible equity — which is much lower than the big boys, which tend to be up around 30.
It’s on 18 times 2016 earnings and 1.8 times net asset value. It’s just increased its quarterly dividend from 8 to 10 cents. But the interesting thing is the revenues are up 19% in the late quarter. It’s got some real momentum going into 2017.
It’s just done another small acquisition of a thing called Carlile Bancshares. This is a Fort Worth bank and also is a broker that buys and sells other small banks — or arranges buying and selling of other small banks. Market cap of $1.2 billion, so it’s at the larger end of the small-cap range. I just think this is very objective and poised to benefit from all the favorable winds that regional banks have right now.
Question: Martin, you told me offline that you love this as an income play, but could we also expect an element of capital appreciation?
Martin Hutchinson: I think we’re going to see capital appreciation in this one, because I think the earnings are going up. It’s acquiring other local banks in its area. But mostly, it should just be able to grow loans. And it can, of course, grow assets without having to take on more capital, because it’s relatively underleveraged.
Question: Wow, so a stable regional bank with a nice dividend and some capital appreciation. You can’t really beat that, can you?
Martin Hutchinson: I think that’s right, yes. Looks pretty good to me.
Question: Thanks for your time today, Martin. This is Wall Street Daily signing off.
Martin Hutchinson: Pleasure being with you.
Senior Analyst, Wall Street Daily