Wow!

It's been quite a few weeks since my last post. I haven't really changed my thoughts since then, but maybe the economic impact of this will have more than a blip on the long term charts after all.

So far, the economy seems to be doing much worse (or will soon) than the stock market. The initial decline was shocking, but not at all unexpected. The recovery rally is kind of incredible too.

As I watch all these commentators, I realize nobody really has any idea. The commentators / pundits that survive a long time are masters at saying things that will make them look 'correct' in hindsight later on. You make enough calls and predictions, you will at least be able to pick one and say you were right. Also, they are very careful to word their comments so that they can't be called out for being wrong. 'If this happens, then this will happen, if that happens, then that might happen...' etc. You say enough of that, and you will be right about something, eventually... It's kind of a joke, but whatever.

Buffett and Airlines

A lot of things have happened since my last post, including the virtual BRK annual meeting. Nothing really new or unexpected, as usual, but one thing that may have shocked people was how Buffett dumped all his airline stocks. We are supposed to be long term investors, and are not supposed to be reacting to headlines, however scary.

But if you look at their income statements and realize that their revenues are down 90% and may be down for a year or more, it's hard to imagine them surviving. Most of them will be out of business by the end of the year or long before that. The government will have to bail them out, but that will be costly. Either they will have to take on a lot of debt that will take years to pay off, or they will have to issue a lot of equity, basically wiping out current shareholders.

Many businesses will not survive this, and even if they do, there will be big losses to equity investors.

A lot of restaurants will go out of business too, but mostly the independent ones. Major chains, especially fast food and fast casual should be fine.

Retailers are out too, for the most part. A lot of retailers should probably not even exist, and this pandemic is just accelerating what is going to happen anyway. The Micrsoft CEO, Nadella, said that there was two years worth of virtualization in two months since the pandemic. I think that's the case with retailers. This will just accelerate the demise of retailers with flawed (or out of date) business models.

No Bargains?

One thing Buffett said was that he didn't really see any bargains during the decline in March. We know from the 2008-2009 crisis that Buffett is not really a trader, so he is not going to be buying the lows on big down days, necessarily. So on fast declines with quick rebounds, he is not going to get much done.

If you look at what's going on, the stocks that were really hit are the ones that you don't really want to own, necessarily. Airlines, real estate, retail, travel-related stocks etc. And the ones you want to own didn't really get cheap. I can see Buffett piling into things like Amazon or Google if they were dumped with the bath water, but they weren't, really. Neither was Microsoft. Not sure what he thinks of Netflix, but that wasn't dumped either.

So crappy stocks got cheap, but as Buffett said, the way to succeed in the stock market (or at least not lose money) is "don't buy crummy businesses". And there are a lot of them out there now.

People also view Buffett as being 'bearish' because he sold stocks, and he is still sitting on a growing cash balance. He did mention during the meeting that he has a lot of cash, but he has a lot of equity exposure too. I wrote about it a while back, but his equity exposure is not limited to his listed equity portfolio. Kraft is not included in his list of stock holdings, but he still owns it. Same with Burlington Northern, and his many other operating companies (some of which were listed until recently).  If you add it all up, BRK is still fully exposed and is not as conservative as it seems if one were to look only at his listed equity portfolio and cash balance.

Which leads to the next thing being talked about a lot these days (as it has been for the last few years).

Value Investing is Dead?

One thing people need to keep in mind about value investing is that the way the general press talks about it and the way investors talk about it are completely different. The press just looks at nominal valuation and that's it. There is no concept of what something should be worth, and whether it is trading above or below that. They don't understand the concept of intrinsic value. Indexes split between growth and value don't help either.

Value investing used to be about low P/E's and things like that, I suppose, but the more modern approach is what something is trading at versus intrinsic value. This is not that modern, actually, as Buffett has been saying that for many decades.

Here is something from the second edition of Graham's Securities Analysis. This is in the section where he discusses the difference between investment and speculation.

It may be helpful to elaborate our definition from a somewhat different angle, which will stress the fact that investment must always consider the price as well as the quality of the security. Strictly speaking, there can be no such thing as an “investment issue” in the absolute sense, i.e., implying that it remains an investment regardless of price. In the case of high-grade bonds, this point may not be important, for it is rare that their prices are so inflated as to introduce serious risk of loss of principal. But in the common-stock field this risk may frequently be created by an undue advance in price—so much so, indeed, that in our opinion the great majority of common stocks of strong companies must be considered speculative during most of the time, simply because their price is too high to warrant safety of principal in any intelligible sense of the phrase. We must warn the reader that prevailing Wall Street opinion does not agree with us on this point; and he must make up his own mind which of us is wrong.

Nevertheless, we shall embody our principle in the following additional criterion of investment:

An investment operation is one that can be justified on both qualitative and quantitative grounds

I would look at the opposite of this example and say that many cheap stocks may not necessarily be safe. Would you buy junk bonds just on yield? Nope. Someone showed me years ago a quantitative report basically showing that the valuation of a stock is pretty much determined by it's credit quality (I don't know if there was an adjustment for long-term growth or returns on capital), but it made sense to me. The industrial cyclicals were always 'cheap', like steel, auto manufacturing etc. And consumer stocks were always expensive.

Anyway, today, I think a lot of this gap between value and growth just may be reflecting huge secular changes in the economy. You can say AMZN is overpriced and BBBY is cheap. But really, who would short AMZN and go long BBBY?

MKL Dumping Stocks

On the 1Q earnings call, MKL said they dumped a few stocks they thought would be hugely affected by Covid-19. Here are the stocks they dumped:

Anheuser-Busch Inbev ADR	0	0.00%	13,000	-13,000	-100%
CDK Global Inc	0	0.00%	176,897	-176,897	-100%
Discovery Communications	0	0.00%	117,000	-117,000	-100%
Dollar Tree Inc	0	0.00%	123,100	-123,100	-100%
Hasbro, Inc	0	0.00%	364,000	-364,000	-100%
Kraft Heinz Co	0	0.00%	68,000	-68,000	-100%
Rockwell Automation Inc	0	0.00%	140,100	-140,100	-100%
Scotts Miracle-Gro Co	0	0.00%	422,000	-422,000	-100%
Unilever PLC ADR	0	0.00%	1,527,600	-1,527,600	-100%
United Health Group Inc	0	0.00%	599,000	-599,000	-100%

This is as of end the March, and they may have dumped more things in April. Buffett dumped airline stocks in April, so that dumpage doesn't show up on his 13-F, which is here, by the way:

BERKSHIRE HATHAWAY INC

Filing Date: 2020-05-15

Name	dollar amt	%port	#shares	change	%chg
APPLE INC	62,340,609	35.52%	245,155,566
BANK AMER CORP	19,637,932	11.19%	925,008,600
COCA COLA CO	17,700,001	10.09%	400,000,000
AMERICAN EXPRESS CO	12,979,391	7.40%	151,610,700
WELLS FARGO & CO NEW	9,276,210	5.29%	323,212,918
KRAFT HEINZ CO	8,056,205	4.59%	325,634,818
MOODYS CORP	5,217,658	2.97%	24,669,778
JPMORGAN CHASE & CO	5,196,030	2.96%	57,714,433	-1,800,499	-3%
US BANCORP DEL	4,563,233	2.60%	132,459,618
DAVITA HEALTHCARE PARTNERS I	2,897,549	1.65%	38,095,570	-470,000	-1%
BANK OF NEW YORK MELLON CORP	2,686,487	1.53%	79,765,057
CHARTER COMMUNICATIONS INC N	2,367,684	1.35%	5,426,609
VERISIGN INC	2,307,964	1.32%	12,815,613	-137,132	-1%
DELTA AIR LINES INC DEL	2,050,935	1.17%	71,886,963	976,507	1%
SOUTHWEST AIRLS CO	1,910,218	1.09%	53,642,713	-6,500	0%
VISA INC	1,701,823	0.97%	10,562,460
GENERAL MTRS CO	1,551,872	0.88%	74,681,000	-319,000	0%
LIBERTY MEDIA CORP DELAWARE	1,446,433	0.82%	45,711,345	-240,000	-1%
COSTCO WHSL CORP NEW	1,235,572	0.70%	4,333,363
MASTERCARD INC	1,192,040	0.68%	4,934,756
AMAZON COM INC	1,039,786	0.59%	533,300	-4,000	-1%
PNC FINL SVCS GROUP INC	880,431	0.50%	9,197,984	526,930	6%
UNITED CONTL HLDGS INC	699,073	0.40%	22,157,608	218,966	1%
SIRIUS XM HLDGS INC	654,149	0.37%	132,418,729	-3,857,000	-3%
KROGER CO	570,475	0.33%	18,940,079
M & T BK CORP	556,665	0.32%	5,382,040
AMERICAN AIRLS GROUP INC	510,871	0.29%	41,909,000	-591,000	-1%
GLOBE LIFE INC	457,278	0.26%	6,353,727
LIBERTY GLOBAL PLC	434,229	0.25%	26,656,968	-481,000	-2%
AXALTA COATING SYS LTD	415,689	0.24%	24,070,000	-194,000	-1%
TEVA PHARMACEUTICAL INDS LTD	384,248	0.22%	42,789,295	-460,000	-1%
RESTAURANT BRANDS INTL INC	337,782	0.19%	8,438,225
STORE CAP CORP	337,425	0.19%	18,621,674
SYNCHRONY FINL	323,860	0.18%	20,128,000	-675,000	-3%
STONECO LTD	308,410	0.18%	14,166,748
GOLDMAN SACHS GROUP INC	296,841	0.17%	1,920,180	-10,084,571	-84%
SUNCOR ENERGY INC NEW	236,195	0.13%	14,949,031	-70,000	0%
OCCIDENTAL PETE CORP	219,245	0.12%	18,933,054
BIOGEN INC	203,440	0.12%	643,022	-5,425	-1%
RH	171,638	0.10%	1,708,348
JOHNSON & JOHNSON	42,893	0.02%	327,100
PROCTER & GAMBLE CO	34,694	0.02%	315,400
MONDELEZ INTL INC	28,946	0.02%	578,000
VANGUARD INDEX FDS	10,183	0.01%	43,000
SPDR S&P 500 ETF TR	10,155	0.01%	39,400
UNITED PARCEL SERVICE INC	5,549	0.00%	59,400
PHILLIPS 66	0	0.00%	227,436	-227,436	-100%
TRAVELERS COMPANIES INC	0	0.00%	312,379	-312,379	-100%
Total	175,485,996

Insurance Companies

By the way, insurance companies are going to hurt for a while. People keep saying that business disruption doesn't cover pandemics, or that it requires physical damage etc. But the way things work in this country, that doesn't matter. We have enough lawyers with a poorly structured incentive system so insurance companies can get bogged down in years and years of lawsuits. Even if insurance companies win, who knows how much all of that is going to cost.

Plus, interest rates are now 0% all the way out to 5 years, and 1% to 20 years. That's going to be painful, and makes BRK's float basically worthless. Yes, this may be temporary, but we have been saying that for more than 10 years now. I have always suspected we will follow Japan in terms of interest rates. I didn't expect a pandemic to cause rates to go to zero, though.

I still think BRK, MKL and others are great investments for the long haul, but there are serious issues for them out there for sure.

Banks
JPM and other banks are going to take some huge credit losses. There is no way around that. One rule of thumb is that credit card losses will follow the unemployment rate. Unemployment got up to 10% during the financial crisis, and sure enough, JPM's credit card charge-offs peaked at 10% or so. Total charge offs were 5%, I think, back then.

Unemployment is now over 15%, and headed to 20%. JPM has $160 billion in credit card loans, so credit card charge-offs can get over $30 billion. Total credit losses may get to 10% and they have around $1 trillion in loans outstanding. Who knows, really.

JPM is still the best managed big bank and they will get through this for sure, but they face some very serious problems. I think the view expressed during the 1Q conference call (expecting rebound in second half of the year) is way too optimistic.

Even if we start to reopen the economy, we can't really have a real recovery as a lot of events won't come back, and restaurant / bars / retailers will run at 30-50% capacity.

An interesting thing to look at is Sweden. They didn't have a hard lockdown like the U.S. and European countries, but their economy is taking a hit anyway. Reopening the economy doesn't mean we are all going to go back to the way we were right away. Many people tell me that they won't change anything even if the economy reopens until they get a vaccine. This could be years away.

I tend to believe things will normalize when we get a treatment that makes Covid-19 far less fatal. If we take that off the table, people will start to get back to normal.

I have no idea about these things, but I tend to think the odds of us finding a treatment is far higher than us finding a vaccine (there is a chance we may never find a vaccine).

Anyway, the mitigating factor to the above bank credit disaster is the amount of money being injected into the economy. I don't know if people are going to use their stimulus / Covid-19 help checks to pay off their credit card (they seem not to be paying their rent), but it will have some positive impact on bank credit, I assume (and hope).  Well, but don't assume because...

Is the Market Being Rational?

So, people are saying that the market is being too optimistic about a return to normal, but it's hard to tell. The market is full of stocks with different exposure. If the airline stocks got back to their highs, I would agree that the market is being too optimistic. But that hasn't happened; not even close. Same with retailers. And restaurant stocks.  OK, Amazon, Netflix, and others are going to new highs, but I doubt that is reflective of the market's optimism about a return to normal.

So when the markets move, I think we have to look by sector, and by stock, to see what they're expecting. It makes no sense to look at the index itself.

What to do?

When this started, I told people the same thing I always told them. Ignore the headlines and just think 3-5 years ahead. This works, though, for people with diversified portfolios. I wouldn't know what to say if they owned a lot of airlines, hotel and other travel related businesses, or other areas that may not recover so quickly. I have no idea.

I haven't owned any retail stocks in a long time (except BRK, which is the closest thing to a retailer I own), and the only restaurant stocks I own are CMG, QSR and SHAK.  Well, SHAK was never cheap so it's a token position that is not significant; it's more of a moral support, I like this company, kind of position. CMG was a large position that I scaled back and had to do again as it went over $1,000. It's not a cheap stock, and I have no idea why it's above $1,000; maybe they are going to take market share after many of their competitors go out of business within a few months). Oops, after writing this, I just realized I do own Costco. So I lied. I own Costco and have no problem with it. I will hold on to it. Yes, it's expensive, but I really like the business for all the reasons we've all heard already a gazillion times.

If you own the S&P 500 index, it doesn't really matter. Many companies will go bust, but that happens all the time. Some big banks, AIG and FNM went bust (or was massively diluted) during the financial crisis and yet the S&P 500 index was fine. It should be fine over the long term this time too, but many of the components won't be.

As usual, just don't invest based on the headlines. OK, evaluating your holdings on long term potential incorporating Covid-19 might not be a bad idea (like Buffett's dumping of airlines), but I would be careful about that too.

One thing is for sure. You really don't want to go chase Covid-19 stocks. You can buy AMZN, NFLX, MSFT thinking these are the pandemic-proof stocks, but the worst time to buy stocks is when everyone piles into them for the same reason (I wouldn't short them either!). For example, I wouldn't touch Zoom stock, of course.

Things are Interesting

I have to admit I have sort of been lazy about my investments over the past few years, kind of just let it go... Looking for things to do wasn't all that interesting as things got expensive.

But things are getting interesting again. I haven't read through so many conference calls and 10-Q's in a long time, and it's been fun. I have to say, though, that the 10-Q's only reflect a small portion of what's happening as the 1Q included the relatively healthy January and February. NYC shut down in mid-March. So there was only 2 weeks of really bad data included in 1Q. The 2Q reports are going to be really scary, but I can't wait to sift through that stuff.

Maybe this will lead to more blog posts. That would be fun, as I do enjoy this process. Until now, though, things are more interesting, but nothing really stands out to me. The really devastated industries are just 'too hard' for now, like cruise lines, airlines, casinos, and the solid businesses that you want to own are not cheap (AMZN, MSFT, COST etc...).

So to those who feel that ETFs and the indexing bubble has lead to a lack of differentiation in the evaluation of individual stocks, it is quite obvious that this is not the case at all. I've always maintained that this is not the case. Sure, there may be excess valuation in some large cap index stocks where index funds are 'forced' to buy regardless. I think overall, crummy stocks are cheap and higher quality stocks are expensive.

OK, banks and insurance companies are cheap now, and not all of them are crummy. But there are massive uncertainties they are facing now. The market is probably wrong and these stocks are probably too cheap.

JPM 2018 Annual Report, Website etc.

JPM's annual report is out, and maybe a good time for another post here. I know it's been a few months. Honestly, I have been coasting recently on what's been working and haven't been digging around too much in the stock market. Most of my time recently has been spent on programming, having taken on a few freelance gigs for fun (and beer money).

Website
Anyway, I have updated my website. A lot of things there were broken, but everything broken there was just due to the Google and Yahoo Finance APIs being shut down completely. This is really annoying. There are a lot of books out there on AI, data science, quantitative finance and all that, and a lot of them depend on those APIs, so it's like those books are worthless now. Well, not really... you just have to find an alternative source of data. But who wants to deal with that hassle?

Anyway, the website is here: brklninvestor.com

The Market Today
One of my favorite pages there is this one: Valuation Sanity Check

People are still talking about how overvalued the stock market is and how it has to go down, and how valuations do matter and that perma-bulls are saying valuations don't matter.

Well, I have been telling people to ignore those people for the past few years, and I, for one, would not say that valuations don't matter. Valuations do matter. The higher the valuation, the lower the future returns. Duh. This is not rocket science. This is no different than bonds. The higher the bond price, the lower the yield, the lower the future return.

Where I disagree with the bears is their conclusion: that if the market is overvalued, then the market must go down. (I am not arguing that markets won't ever go down; they will with 100% certainty. But I doubt anyone can tell us with any consistent accuracy when it will!)

I also quantified this and put the data on the website.

Future returns in an overvalued market

I didn't update it, but since the market has been up, the conclusion would be the same or better. Plus, the analysis uses decades of data, so a couple of years is not going to make a difference.

As for all the worries and concerns, Buffett's 2018 letter has a great section called "American Tailwind", and it basically says that the market has done well over the past 77 years and there were always things to worry about, but the market did pretty well. Maybe more on that in another post.

Anyway, the home page shows the trailing P/E ratio of the S&P 500 index at 21x, and forward P/E of 17x.  This may seem high to some of us who started in the stock market business when interest rates were around 8%. They are now much lower than that. I've said in posts that with a "normalized" interest rate of 4% over the next decade, I would not be surprised if the market P/E averaged 25x P/E.   So a 21x P/E is not at all alarming or shocking to me, and the 17x forward P/E actually looks pretty attractive, even assuming that forward estimates tend to be over-estimated.

Also, looking at the Valuation Sanity Check page, the Dow 30 stocks seem to be trading at 17.5x 2019 estimates and 15.4x 2020 estimates.  The Berkshire stocks (just the stocks listed in the annual report) are trading at 15.4x and 13.4x 2019 and 2020 estimates.

Again, there are issues of the validity of 'estimates', but even still, these figures are nowhere near bubble levels.

My thoughts about the market hasn't changed at all in the past year. Yes, it was a little scary in the fourth quarter of last year, but I was not that particularly worried as none of my work (as shown in previous blog posts) has shown any rubber band stretched to it's limit that must snap back.

OK, anyway, maybe more on that another time. Going on to my next pet peeve...

Data
Google and Yahoo have no obligation to continue their finance data APIs, of course. But what is really annoying is how expensive simple financial data is. It has always been so, and Google/Yahoo made it affordable (or, well, free) for the little guys without big corporate budgets. But that is gone now.

As the world continues to move towards open source and open data (look at this great source of free data related to NYC: NYC Open Data), the financial industry continues to be closed and expensive.

There was an article in the FT today about people (even rich corporate users) complaining about stock exchanges gouging them on price for access to basic data.

As I see it, stock exchanges are basically public utilities. I don't think they should be profit-making entities so long as they are given a legal monopoly (or oligopoly or whatever).

It's just makes no sense that we stock market traders/investors must go through the exchanges to trade and the exchanges then accumulate and use that data and sell them for profit. It just makes no sense at all. This stuff should be public information and easily available to the public in various forms. It doesn't cost that much money to provide an API where people can access this information. We can see they are already making tons of money on exchange fees etc.

So this is just nuts.

OK, so it's not a huge issue for me as stock prices / data is not a big part of what I do. As you know, I am more about listening to conference calls and reading 10-K's and stuff. The only time I use financial data was when I was putting stuff up on the website for fun; I don't need that stuff to invest (and that's why I haven't paid for any data service, and don't really plan to).

The idea of open-source is that if you make the information free and widely accessible, more people can play with it and more ideas can come out of it.

OK, enough of that...

JPM 2018 Letter
No offense to Mr. Buffett, but I sort of look forward to Dimon's letter more than Buffett's these days. Buffett still writes great letters and I read them as soon as they come out. But I feel like I am very familiar with what he has to say and there are usually no surprises, and I am not sure I really learn anything from reading them lately.

But Dimon's letters are much more granular and deal with a lot of specific, current issues etc.

Anyway, I don't plan on going into detail here as you can just go read it yourself (and I know many of you won't, but I don't care... it's your loss if you don't!).

Here are my usual favorite charts.

Dimon Tenure Performance
These tables are really great; they show how Dimon has done as a CEO.

For reference, BRK BPS grew +9.5%/year from 1999-2018 and +10.0%/year from 2004-2018. So you can see that JPM has done better than BRK in both time periods, which is kind of shocking when you think about the fact that one period includes the popping of the internet bubble in 1999/2000, and both time periods include the financial crisis.  (BRK time periods are based on year-ends, so don't match up exactly, but whatever...)

Below is the same look but based on the stock price instead of TBPS. BRK's stock price appreciated around +9.3%/year in both time periods (1999-2018, 2004-2018).  This is kind of insane.

Social / Political Issues
I will not repeat them here, but Dimon goes on in great detail about how we can make things better here in the U.S. It's too bad that our system does not allow for people like Dimon to become president. He would make an incredible one.

Anyway, he does caution us away from the creeping socialism and rising progressives from the far left. I am actually very sympathetic to this recent movement even though I am a hard-core capitalist. But I can see how it can be dangerous for us to veer too hard to the left and destroy things that have worked for us.

But the fact is that what has worked for "us" hasn't really been working for a very large number of people.


Conclusion
It's been a while, but I haven't really changed my mind on anything at all. Nothing new to report, really. The market looks fine. No bubble at all as far as I'm concerned. Maybe not cheap, but not really that expensive either.

The way stock exchanges use data as profit centers is deeply disturbing and is not consistent with what I think of as their mandate as virtual public utilities. The whole system of exchanges charging money for data, and a whole industry of data vendors runs contrary to the worldwide trend everywhere else of open-source and open-data. 

OK, way back in the old days when you needed expensive mainframes to manage this stuff, it may have been understandable. But with technology where it is today, this whole data industry setup and cost makes no sense at all. The industry must be laughing their way to the bank as costs keep going down and the prices they charge keep going up.

JPM continues to do well and it looks like in may ways they are disrupting themselves, which is really great. It assures (or increases the odds) of their continued success.

They have come a long way since I opened my first bank account at Chase many years ago.

I probably told this story here before, but I'll tell it again. When I had my first job in the city, I needed to open a bank account somewhere so my employer can deposit my paycheck.

I figured all big banks are the same, so I went to the World Trade Center (near where I worked and lived) and walked into Citibank. There was a reception desk at the front and I said I wanted to open a bank account.

A big-haired girl, loudly chewing gum and filing her nails barked at me, "I'm on break. Come back later...".  She was sitting at the reception desk/booth. I was shocked at how rude she was, so I just walked across the hall to Chase and said the same thing, and someone immediately came and helped me out. Chase was not that much better; it was pure chance that the Citi employee was on break and Chase's wasn't.

This is the only reason why I started at Chase. Unbelievable. But that's how big banks were back in the 90's. Just terrible. Like the post office.

Anyway, JPM is no longer no-brainer cheap like it was when this blog first started (2011), but it still seems pretty cheap.

JP Morgan 2016 Annual Report (JPM)

I haven't posted much about JPM recently as it's still basically the same story. Great CEO building an awesome company performing really well etc.  After even a couple of posts, they are basically the same.

But since I haven't been too active here recently, I figured why not? Let's take a look at this. There is a lot to learn here, not just about banking and the economy, but about markets and investing too.

So first of all, let's look at how well JPM has done in recent years. And it's not just because of the huge bull market since 2008. If you look at the performance figures below, they go back to 2004, and the performance chart in the proxy is from 2007, which is the benchmark I use to get 'through-the-cycle' returns.

Anyway, Dimon's Letter to Shareholders is really good so go read it if you haven't done so already. I sort of look forward to this one even more than Buffett's lately.

Check out the total return of JPM stock over various time periods:

This is really crazy given what has happened since 2000 and particularly after 2007. Back in 2000, I don't think anyone would have guessed JPM stock would outperform the S&P 500 index over the next 16 years. People were bearish the financials after the collapse of the 1999/2000 internet bubble, especially JPM which had a large investment bank attached to it with trillions in notional derivatives outstanding. For years, JPM has been considered the first domino in the coming financial collapse.

And yet, look at that! Yes, bears will argue that JPM got bailed out during the crisis etc. I've talked about that a lot here so won't go into it too much, but I disagree. I agree that the government bailed out the whole system, which is what it should do (that's what the Fed is for, and that's what the government has the power to do in extraordinary situations).  But I don't think JPM was in any danger unless the whole system itself collapsed, in which case nothing would matter anyway. 

So let's look at the performance of the company itself:

This is just totally insane. TBPS has increased even more than the stock (total return).

Here's a chart from the proxy that is indexed to 2007:

That's a 10.5%/year return since 2007.  That's crazy. Let's say you knew that the worst financial crisis would come and almost destroy the country. People would have called you an idiot if you said, "Fine. I don't care. My stock will return 10.5%/year over the next 9 years!".  In fact, I did own JPM and didn't sell in front of it, even when cracks appeared. I didn't sell any during or immediately after either. 

Investment Lessons
And here's sort of the lesson on investing. It was widely known that Dimon was a super-competent manager when he took over Bank One. I think he was already considered at the time one of the best managers in finance. When he left Citigroup, many thought C would collapse because Dimon was the detail guy that made sure everything was OK.  Sandy was a big picture guy while Dimon chased after the details. No Dimon == noone looking at the details => eventual blowup. (I heard this from someone that was there at the time and watched how they worked up close too.)

But a lot of people didn't invest in JPM because it was a large money-center bank and banking cycles tended to be severe. Everyone remembers the banking crisis of the 1970's and the late 80's/early 90's.
So the thought was 'thanks, but no thanks'.  I confess I was one of those. I've owned Bank One since forever and JPM too, but never allowed it to become a huge position because of that. (On the other hand, I would not mind being 100% in Berkshire Hathaway, even though BRK has gone down 50% on a number of occasions).

In 2007, bank stocks were expensive and we were at the tail end of a very long credit cycle. Contrary to the claims of some best-selling books, the leverage built upon shrinking credit spreads was pretty well-known within the industry. It would have been wise to not be too exposed to financials at this point.

But, when you own a great business run by great people, it is often better off to ride out the cycles than to try to time them.  And that's another lesson here with JPM stock. This is not really hindsight trading either, as I would have told you back in 2007 (and I think I did even though this blog was not in existence back then) that JPM and GS would be the survivors in any crisis, and they would come out the other end bigger and stronger (as Charlie Munger says about how great companies grow; they grow in bad times, just like Rockefeller, Carnegie and everyone else did).

The argument back in 2007 really focused a lot on the notional derivatives outstanding at JPM. This was one of the major red flags that kept some investors away. I have managed derivatives before so understood that notional amounts outstanding is not a measure of risk. When you are a big banker and dealer, you end up with huge amounts of notionals outstanding because, for example, if you issue bonds for an issuer, you sometimes do interest rate swaps to accommodate the client's cash flow needs. Same with FX. As a major FX dealer, you often use swaps as a tool to help risk-manage clients' risk exposure.  Those 'straight' swaps often have very little risk.

Cyclical or Secular?
The other lesson is that markets have cycles. After the financial crisis and after JPM has shown its resilience and management competence, it traded cheaply for a long time. Even the most prominent bank analysts would say things like, "Yes, it's cheap, but there is no reason to own it as regulations make it hard for them to make money...". I've heard that argument over and over again post-crisis.

But these folks held a linear, static model in their heads. They didn't realize, or underestimated how the industry would adjust to new regulations and requirements. If the regulatory capital burden got too heavy in a line of business, they would drop it. They can cut expenses. They can reprice products as new regulations apply across the industry.  Sure, they may not get back to bubble-era returns, but banks don't need to to be good investments.

Maybe this was due to the short-term nature of Wall Street; with regulatory headwinds and low interest rates, bank stocks were simply not recommendable.

Either way, long term value investors look to invest in great businesses at reasonable (or cheap if available) prices.

And interestingly, now, hedge funds and others seem to be piling into banks.  Nobody wanted JPM at $20 or even $40, and now they are piling in at over $80!  And people say the market is efficient, picked over etc.?

I think all of this sort of just illustrates the cyclical nature of markets. The key in successful investing is being able to see the difference between cyclical and secular. It's true that this is very hard a lot of the time. But I never thought banking itself was in secular decline. Every year, Dimon has shown how much business needed to be done over the long term in banking.

Regulations tend to be cyclical too as the pendulum can swing wildly from one extreme to the other. We are now seeing the pendulum start to swing back the other way. As Dimon says, a lot of this can be done (simplify regulations) without congressional action.

By the way, I have a lot to say about this, maybe in future posts, but I do believe that this max exodus out of hedge funds too is cyclical, as is the move towards machines (vs. people) / indexing. I do believe that most hedge funds probably don't deserve to exist, and machines will more and more take over money management, but I think it will still be very cyclical.  We have seen this before in the past; move to quantitative money management, indexing vs. active, hedge funds vs. index etc...

Buffett and WFC
And this sort of thing explains why Buffett has been buying WFC for all these years, even right before the crisis. I always heard comments like, "doesn't Buffett see this big trouble brewing? This huge storm?  Doesn't he understand that the era of big banks is over?". He has been buying before, during and after the crisis at 'high' prices.

He focuses on what a business can earn on a normalized basis over time, so he doesn't care about the short term outlook. He doesn't care about what other people say. He doesn't worry about downturns as strong institutions should be managed to survive and grow in such situations. Trading in and out to avoid such dips is a loser's game.





2x Tangible Book
Dimon says it was a no-brainer to buy back stock at 1x tangible book, but says this year that it still makes sense to buy back stock at 2x TBPS. That would be over $100/share!

That sounds insane. Who would have even guessed JPM would be closing in on $100 just a couple of year ago? 

Assuming a 50% payout ratio on $6.00 or so in EPS, that would be $3.00/share in dividends.  Using a $100/share price, that's a 3% dividend yield.  Assuming JPM grows along with the economy (4% nominal), that's an expected total return of 7%/year against what I would assume a normalized long term rate of 4% (actual is 2.3%).  As a sanity check, EPS grew around 4%/year from 2007 to 2016. 

OK, students will immediately jump on me and argue that earnings growth should be 6.5%/year for a 9.5%/year return (50% retention at 13%). Well, JPM is a big bank so it may not be able to grow that much more than GDP over time, so let's just say earnings grow at nominal GDP.  That would just mean that payouts would be higher as capital can't be invested at a 6.5% growth rate.  

In that case, payouts may be 70%.  On a $6/share EPS, a 70% payout is a $4.20/share dividend for a yield of 4.2% (again, at a $100 stock price).  4.2% dividend yield plus 4% growth is 8.2% expected return. 

This reminds me of Buffett talking about how he bought a stock yielding more than the financial products the company was selling. 

Of course, as we wait for things to normalize, bad debt may normalize too; JPM is sort of over-earning in the sense that credit trends are really good now. This has probably bottomed out and should head higher. I don't think there are any time bombs at JPM, but it will sort of be a race on the economy picking up steam and interest rates normalizing versus credit trends bottoming out. 

But of course, stocks never trade at what they are supposed to trade at. Which leads to my next digression.

Models and Odds: Ed Thorp Book
I was actually going to make this a whole separate post; maybe I still will.  But writing the above got me back to thinking about models, odds and things like that.

This goes back to the argument about stocks being expensive or not, wondering about being short because the market is overpriced and losing money for years on end etc.

I just finished this book by Ed Thorp:  A Man for All Markets

And I have to say it's one of the best books I've read in a long time. It's not a manual like Securities Analysis or the Greenblatt books, but an autobiography.  But it is a fascinating read. Some may be disappointed by the lack of mathematical details, but this is not meant to be that sort of book. In any case, the math involved in what he talks about is widely available now anyway. But the thinking that went behind figuring all this out is fascinating.

Other than his adventures in Las Vegas, I've been involved in just about every area he talks about in the book, from options, warrants, convertible bonds, closed-end funds, even the Palm stub trade, statistical arbitrage etc. (One thing he fails to mention about the Palm trade is that even though it looks like the market is inefficient, in some cases, there is no stock to borrow to implement the trade; rebates go through the roof and reduces or takes away potential profit etc... The stock lending side is often not as visible).

For Buffett fans, there is a whole chapter on Warren Buffett, which is fun to read. They knew each other and Buffett even checked him out over dinner long ago.  Thorp also invested in Berkshire Hathaway but moved his money elsewhere as returns went down as BRK got larger.

One interesting fact that Thorp mentions is that the Buffett partnership returned 29.5%/year, gross, in the 12 years from 1956-1968 versus 19%/year for small caps stocks and 10% for large caps. I knew Buffett made his money buying small/microcaps back then, but it was surprising that a good half of the outperformance came from the small cap bias.  Maybe I should not have been surprised.  But anyway, I did take note of that as I read the book.

OK. Back to models. Early in my career, I spent a lot of time creating models; economic models, stock market valuation models, statistical models, single stock valuation models, technical trading systems, mean-reversion trading models (early stat-arb) etc...

And what struck me while reading the Thorp book was the difference between the typical economist who creates models and the traders that write models.

Economists plug in all these numbers and tell you that the economy should do this or that, and that the market should be valued here or there. And sometimes, they get all caught up in their models and think they are absolutely right and get their head handed to them.  I've seen this happen time and again. One benefit of working at a large firm was that I sat through many presentations (people pitching big banks to fund their proprietary trading models/ideas).  And a lot of the ideas lacked real world common sense.

And then you read what Thorp did. For example, he created the option model before or at the same time as Black-Scholes etc. This model told you what an option or warrant was theoretically worth. But the model would have been useless if there wasn't a way to capture the price difference. You can hedge the option by trading the stock and capture any mispricing.

All of the strategies that Thorp was involved in had very specific odds attached to them, including the possibility of adverse outcomes. What are the odds of this or that? What happens when you are on an expected, normal losing streak? You have to have enough capital to be able to stay in the game. Traders' models usually have a "what if this happens, or what if that happens? what are the odds of this or that happening?".  Economist models are like, "This is what will happen and all the back-testing proves it will happen... we have calculated to the seventh decimal places using 30 models and they all confirm we are right". If you ask them, but what if reality deviates from the model? They say, "it won't because we are right".

Even some investors I respect had a huge hedge on their equity book that lost them tons of money. It made sense on the surface; stocks are expensive so we must hedge our equity exposure. The problem is that, as I have shown in previous posts, overvaluation is a very poor reason to go short the market or put on hedges (well, it might make sense to do some hedging).

I've seen the bubble in Japan in 1989 and the U.S. bubble in 1999 and I would guess that most people who correctly identified those as bubbles didn't make money when the markets collapsed. It was stunning how many funds were hurt during the late stages of the bubble and weren't around to capitalize when they were proven correct.

The problem with overvalued markets is that the odds of a blow-off are pretty high, and when things blow off, the more expensive things are, the higher they go. So, if you own a bunch of value stocks and hedge using the S&P 500 index or some other market cap-weighted index, you will probably be destroyed as the expensive large caps will go up the most.  (This reminds me of something I did long ago; I owned some value stocks that went up 20-30% so was proud of myself, but was short Starbucks against it and that doubled... Oops.  So much for hedging a value portfolio with a growth/mo-mo stock).

There was an interesting article recently that said that a bubble isn't a bubble unless the market has gone up 100% over a period of two or three years or something like that.

This is why people like Thorp would not make directional bets on the market. One can easily observe that markets are expensive, but what is the edge that that specific observation brings to you?  I remember Buffett telling someone, when shown a chart of how overvalued the stock market is, that it's just a squiggly line and it can go this way or that way, who knows which way it would go? That seemingly 'clueless' response is much wiser than it seems on the surface.

If you hedge using market-cap weighted indices or go net short, can you survive a real bubble-like blow-off? What are the odds of such an event occuring?  Is it really zero? I bet that this is not even incorporated in most models or the thinking of most investors. Of course, most of the quant funds would have this worked out (or hedged out); quants don't like to take risks that they can't hedge.

On the other hand, if you are a long manager, do you need to care about the odds of a correction? No, because if you own solid stocks that won't go bust (like owning JPM from 2007-2016), then corrections don't really matter. You just ride it out. The only way the market can break you is if the companies you own actually go out of business.  Otherwise, you may just have to wait longer to realize value. But otherwise, there is not that much risk.  This is not true when you are short, of course; it is much easier and probability of survival higher for a long to live through a bear market than the other way around.

Cheap Labor
Back to JPM. The great thing about JPM is that we get all of this for so cheap. OK, 'cheap' may be offensive to average folks out there earning normal salaries. So I shouldn't say that too much. But still, cheap is cheap. We paid Dimon 0.1% of profits. Compare that to other financials! (from the proxy).  Let's not get into hedge fund fees here.

...also from the proxy:

And for the Berk-heads here, a familiar new face on the board:

OK, this is getting way too long.  There is a lot more in Dimon's Letter to Shareholders so go read it. I may post more about it later (but maybe not), but let me just get this post out before more time goes by without a post!

JPM Annual Report 2015

It's been a while since I last posted.  The only explanation, I suppose, is inertia.  When you post a lot, you post a lot.  When you don't post for a while, then you stop posting.  It's true I started getting busy in September last year (kid/family stuff, mostly, so good stuff).  And then you just get used to not posting etc.

Anyway, some of my favorite annual reports are out, so I thought I'd use that as an excuse to break the silence and try to get back into posting more regularly.

The JPM report, as usual, is really well written.  I see a lot of people have a lot to say about it and I guess that's good, that it gets attention and gets people talking about the various issues.

I noticed Cramer saying that Dimon is whining too much and that he should admit and talk about all the things that JPM has done wrong and not just criticize regulations/policy.  To be fair, Dimon has talked a lot about what JPM and the industry has done wrong over the years, often in real time.  He has been doing that for years, so it's not like he hasn't taken responsibility for a lot of what's coming at the industry these days.

But I do agree that a lot of this stuff (anti-corporate, anti-big-bank rhetoric) seems to be going overboard.  As usual, people tend to expend a lot of energy fighting the last battle (and missing what's coming next!).

Anyway, enough of that.  Let's take a look at some cool charts.

Performance
Dimon's letter is full of great charts.  I wish more annual reports were like this. But then again, if you don't have a great historic track record, you wouldn't want charts like these in the first few pages of your report.

For many years since the crisis, people kept saying that JPM is putting up fake profits by reversing loss reserves and that when that runs out their earnings will tank.  Or that spread compression will continue so their earnings will tank on that.  Or that increasing capital requirements will hit their earnings. Well, they've been saying these things for years but JPM made record profits again in 2016.

And tangible book value per share has been rising every year since 2004.  Since the 2007 peak, TBPS has increased 10.3%/year.   That's pretty astounding.  This includes the great recession/ financial crisis, and the Whale 'disaster'.

TBPS has outperformed the S&P 500 since Dimon became CEO of Bank One, and since the Bank One/ JP Morgan merger.

Total return of the stock hasn't been as great, though.  But a CEO can't really control the stock price.

Dimon regrets that the stock price, while outperforming the industry, has only kept pace with the S&P 500 index.

Just for fun, and since Dimon and most of us are Buffett fans, I'll compare these figures with Berkshire Hathaway (BRK).  This may not be totally fair as I will compare tangible BPS growth of JPM with the BPS of BRK.  BRK does have a lot of goodwill on the balance sheet so it will make a difference.  So keep that in mind.  Still, BRK's BPS growth is a decent benchmark for performance of a great CEO.

First, let's just look at the BPS changes:

                          JPM            BRK
2000-2015        +12.5%        +9.2%
2004-2015        +13.7%        +9.8%
2007-2015        +10.3%        +9.0%
1 year                +7.9%          +6.4%
5 year                +9.8%          +10.3%
10 year              +7.9%          +10.1%

The figures for JPM are from the tables/charts above.  The 1, 5 and 10 year figures exclude dividends as I just looked at the TBPS chart.  JPM figures start during the year for 2000 and 2004 whereas for BRK, I just used the closest year-end figure (so as to minimize my work-load).

The bold figure is the higher one.  You will see that JPM has outperformed BRK in just about every time frame, even from the 2007 high.  That's really crazy when you think about it  (The five and ten year exclude dividends so is understated).

In 2007, right in front of the worst financial crisis since the great depression, if you knew exactly how bad it was going to get, you would never guess that JPM will outpeform BRK over the next eight years.  JPM had trillions and trillions of derivatives exposure, billions of mortgages, investment banking business exposure etc.  And BRK was a rock solid winner in bad times with the greatest capital allocator of all time etc.


OK, let's look at the stock price.

                          JPM            BRK
2000-2015      +10.2%          +8.2%
2004-2015        +7.6%          +7.6%
2007-2015        +7.8%          +4.3%
1 year               +8.4%          +1.4%
5 year              +12.1%       +10.4%
10 year              +7.9%          +8.3%

By stock price, JPM outperforms in just about every time frame too.  This one doesn't have the tangible BPS versus BPS problem, so is 'pure' in that sense.   Not bad at all.


Best in Class Across the Board
And it's not like JPM is doing well in one area versus another.  It seems like they perform consistently in all areas, which is reassuring.

Break Up the Big Banks?
Dimon spends some time talking about the big bank issue.  You may not agree with everything he says (I do, though... surprised?), but he raises many valid points.  The thing that annoys me about this argument is that the biggest problems (well, OK, Citi was a problem) were Lehman, Bear Stearns, Merrill Lynch and Morgan Stanley.  Oh, and AIG, which wasn't even a bank or investment bank.

JPM, WFC and even BAC did fine throughout the crisis.  Well, BAC got into trouble for what it did during the crisis, but I think they were fine going into it.

Anyway, here are some interesting charts in Dimon's letter that shows that our big banks aren't even that big, relatively speaking, compared to other countries.

Call me stubborn (or stupid), but I still think Glass-Steagall is not an issue, really.  I know many veterans on Wall Street (even the ones that wanted it repealed) believe that Glass-Steagall should be reinstated and that investment banks and commercial banks should be separated.

This has never made any sense to me.   If you are a financial services company and have a client that needs to raise funds, why should there have to be two separate entities depending on if you want to borrow money from you (as a bank) or sell bonds to your clients (as an investment banker)?

I remember reading about the old days when institutions were highly regulated, based on things like if you are making long term loans or short term loans, interest rates were regulated etc.  In fact, the S&L industry was very highly regulated and they blew up spectacularly.  I don't think any one S&L was big enough to threaten the financial system, but they all seemed to blow up at once.  Too big to fail? Or too many to fail?

The Solution
Buffett probably has the best answer to all of this; clawbacks and make sure that the CEO ends up in the poorhouse if their bank fails.  The fact that the CEOs that blew up their firms during the financial crisis are playing golf at exclusive clubs and are living rich is really annoying even to me (the big financial industry groupie/cheerleader).   OK, this has nothing to do with Dimon's letter.

Increasing capital requirements drastically may not matter as many banks that blew up early in the last century had very high capital ratios.  Turning banks into utilities, as Dimon says, makes no sense either.  Utilities are monopolies, first of all.  Banks are not.

Utilities have their own problems, and they've had their own blowups.

Interest Rates

In the letter, Dimon says he is not worried about negative interest rates.  He is in fact much more worried about interest rates going up faster than they expect.   And in the Goldman Sachs letter, Blankfein/Cohn say, "We don't see how a world of zero or negative interest rates could possibly be the 'new normal'".  

To which I say, "but what if it is!!??!". 

That would be my big fear for financial stocks.  We have all been watching the impossible happen, first in Japan, and now in Europe.  Yes, we are better here for sure.  But how much better?  Can we really avoid this 'new normal' if it continues in Japan/Europe etc.?  Are we strong enough to resist such a strong force?  Even the strongest swimmers will drown if weighed down by an anchor heavy enough...  I don't know.

Anyway, the letter is a great and educational read so go read it!

Proxy
By the way, there is a shareholder proposal in the proxy.  But before that, let's take a look at some charts from it.

So Dimon's pay is performance based, and we are getting a great deal.

Anyway, here is the proposal:

Proposal 7Appoint a stockholder value committee — address whether divestiture of non-core banking business segments would enhance shareholder value

Bartlett Naylor, 215 Pennsylvania Avenue, S.E., Washington, D.C. 20003, the holder of shares of our common stock with a market value in excess of $2,000, has advised us that he intends to introduce the following resolution: 

Resolved, that stockholders of JPMorgan Chase & Co. urge that:

1.	The Board of Directors should appoint a committee (the ‘Stockholder Value Committee’) composed exclusively of independent directors to address whether the divestiture of all non-core banking business segments would enhance shareholder value.

2.	The Stockholder Value Committee should publicly report on its analysis to stockholders no later than 300 days after the 2016 Annual Meeting of Stockholders, although confidential information may be withheld.

3.	In carrying out its evaluation, the Stockholder Value Committee should avail itself at reasonable cost of such independent legal, investment banking and other third party advisers as the Stockholder Value Committee determines is necessary or appropriate in its sole discretion.

And here's the supporting info: 

The financial crisis that began in 2008 revealed that some banks were “too big to fail.”  This is the moral hazard that invites managers to take extraordinary risks with an understanding that taxpayers will rescue the firm, as failure would cause widespread financial chaos. That 2008 rescue may have served JP Morgan’s creditors, but shareholders suffered. JP Morgan stock fell from $49.63 on Oct 1, 2008, to $15.93, on March 6, 2009.  

Risk-taking at major banks can be especially lethal following the elimination of certain activity restrictions (known in the vernacular as “Glass-Steagall”) on how a bank can deploy FDIC-insured deposits. Congress began to address some of these problems with the 2010 Dodd-Frank Act. But an analysis by Goldman Sachs argues that implementation of this law means JP Morgan would be worth more in parts. 

The crisis and subsequent events have also demonstrated that JP Morgan may be “too big to manage.” Mismanagement of deposits by a half-dozen London-based traders (known as the “London Whale”) sent JP Morgan stock down 24 percent. Further, shareholders have paid more than $30 billion in fines because bank managers failed to prevent misconduct in a variety of operations. 

We therefore recommend that the board act to explore options to split the firm into two or more companies, with one performing basic business and consumer lending with FDIC-guaranteed deposit liabilities, and the other businesses focused on investment banking such as underwriting, trading and market-making.  Divestiture would also give investors more choice and control about investment risks.

You can go read JPM's response to this, which is good.  But what I was thinking as I read this was:

• Well, the stock price declined a lot, but JPM didn't lose money in any single quarter throughout the crisis!  Look at the charts in the letter to shareholders.  There is not even a blip where the financial crisis occured (in terms of TBPS). 
• My old-fashioned thinking is that Glass-Steagall's elimination can't be the cause of the crisis because the biggest problems occurred at independent investment banks.  In fact, GS, MS and others wanted to become attached to banks to enhance stability; this is exactly the model at JPM, and that is why JPM was so stable throughout the crisis.  Citibank had problems, but that's a whole other story,  I think. 
• The London Whale trade made the JPM stock price go down, but it was pretty inconseqential, relatively speaking (loss versus shareholders' equity etc.).  Ironically, in hindsight, it's basically a tempest in a teapot...  
• JPM paid $30 billion in fines, but other firms paid a lot of fines too.  GS, MS and others paid fines too because "managers failed to prevent misconduct in a variety of operations".  

Anyway, as it says in the proxy, JPM has described at their investor days in the past few years why the integrated model makes sense. 

OK, so that wasn't so hard (to make a blog post after three months!). 

JPM Annual Report 2014

The 2014 JPM annual report was finally released last week and it's a great read as usual.   Dimon takes his time to talk about the goods and the bads, industry trends, competitive threats and all kinds of things.  It's one of those letters (like Buffett's) that you learn about all sorts of things reading it, not just about the company.

Anyway, here are the usual charts showing JPM's performance in the recent past.  Nothing new here, of course.

And my favorite chart is the tangible BPS growth over the past ten years:

And here are some long term performance metrics that show how Dimon has performed as a CEO:

These are pretty impressive figures.  For reference, since the end of 1999 (close enough to 3/27/2000!), BRK and MKL grew BPS at 9.4% and 14.8% respectively.   Dimon grew tangible BPS 12.7%/year from March 2000.    And this is a regulated bank that went through the financial crisis.  Yes, it's tangible BPS versus regular BPS for MKL and BRK.   But still, it's impressive.

Since the merger, Dimon grew tangible BPS at a rate of 14.1%/year.  Again, this is not a perfect comparison but BRK and MKL grew BPS at a rate of 10.1%/year and 12.5%/year.  BRK and MKL are 10 years through December 2014, and both are BPS, not tangible BPS.  Again, keep in mind that the merger happened in 2004 so this period includes the financial crisis.  It's crazy when you think about how well JPM has done.

Stock Total Return
Of course, what really matters, though, is total return to the shareholders.  And here too, JPM has done really well over the long term.

Better than BRK?!
I actually didn't know this until I just calculated it, but if you owned Bank One when Dimon became the CEO and held your shares through the merger and through December 2014, you would have done better than owning BRK over that time period. 

Bank One/JPM had a total return of 10.4%/year during the period 3/27/2000 - 12/31/2014, and BRK shares returned +8.7%/year during that time.   That's kind of nuts when you think about it.  Bank One was a boring bank.  And JPM was a leveraged, risky house of cards; an almost-certainly-the-first-to-fall-in-any-financial-crisis money center bank.   And it has done better than BRK over the past 14 years?

And you don't even have to look at the comparison with the S&P Financials index.  A more direct comp would be Citigroup and Bank of America, but we don't even need to get data to see that JPM did better.

Dimon does note, though, that the stock has not done well recently:

However, our stock performance has not been particularly good in the last five years. While the business franchise has become stronger, I believe that legal and regulatory costs and future uncertainty regarding legal and regulatory costs have hurt our company and the value of our stock and have led to a price/earnings ratio lower than some of our competitors. We are determined to limit (we can never completely eliminate them) our legal costs over time, and as we do, we expect that the strength and quality of the underlying business will shine through.

He says that the legal costs should normalize by 2016 implying that the uncertainty discount may go away around then.

Best in Class by Segment
Efficiency and returns are close to best in class in all segments.  Dimon notes that this was achieved while continuing to invest for growth.



...and while building up capital.

A lot of this stuff was in the investor day presentation, but it's worth showing again.   We tend to think of the big banks as having horrible customer service and those smaller guys with coin/change counting machines and no-bullet-proof-glass-so-gets-robbed-all-the-time smaller banks (that call their branches stores) are popular.

But the gap seems to be closing.

No Split
And here's the part about the value of JPM as it is.

Our mix of businesses works for clients — and for shareholders All companies, including banks, have a slightly different mix of businesses, products and services. The most critical question is, “Does what you do work for clients?” Our franchise does work for clients by virtue of the fact that we are gaining share in each of our businesses, and it works for shareholders by virtue of the fact that we are earning decent returns – and some of our competitors are not. 

...and later he says:

Our mix of businesses leads to effective cross sell and substantial competitive advantages. We are not a conglomerate of separate, unrelated businesses — we are an operating company providing financial services to consumers, companies and communities 

A conglomerate is a group of unrelated businesses held under one umbrella holding company. There is nothing wrong with a conglomerate, but we are not that. In our case, whether you are an individual, a company (large or small) or a government, when you walk in the front door and talk with our bankers, we provide you with essential financial products, services and advice. We have a broad product offering and some distinct capabilities, which, combined, create a mix of businesses that works well for each of our client segments.

I don't want to cut and paste everything here, but he goes on to talk about how there are some things that only big banks can do and smaller community banks can't.  Things only global institutions can do etc.   Also, he talks about how big is not always more risky.

CCAR
And there was an interesting discussion on the Fed's stress test.  Dimon thinks that JPM will do better than what the test results imply.  I'm gonna paste that because it is very interesting:

The Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) stress test is another tough measure of our survival capability. The stress test is good for our industry in that it clearly demonstrates the ability of each and every bank to be properly capitalized, even after an extremely difficult environment. Specifically, the test is a nine-quarter scenario where unemployment suddenly goes to 10.1%, home prices drop 25%, equities plummet approximately 60%, credit losses skyrocket and market-making loses a lot of money (like in the Lehman Brothers crisis).
To make sure the test is severe enough, the Fed essentially built into every bank’s results some of the insufficient and poor decisions that some banks made during the crisis. While I don’t explicitly know, I believe that the Fed makes the following assumptions:

• The stress test essentially assumes that certain models don’t work properly, particularly in credit (this clearly happened with mortgages in 2009). 

• The stress test assumes all of the negatives of market moves but none of the positives. 

• The stress test assumes that all banks’ risk-weighted assets would grow fairly significantly. (The Fed wants to make sure that a bank can continue to lend into a crisis and still pass the test.) This could clearly happen to any one bank though it couldn’t happen to all banks at the same time. 

• The stress test does not allow a reduction for stock buybacks and dividends. Again, many banks did not do this until late in the last crisis.

I believe the Fed is appropriately conservatively measuring the above-mentioned aspects and wants to make sure that each and every bank has adequate capital in a crisis without having to rely on good management decisions, perfect models and rapid responses.

We believe that we would perform far better under the Fed’s stress scenario than the Fed’s stress test implies. Let me be perfectly clear – I support the Fed’s stress test, and we at JPMorgan Chase think that it is important that the Fed stress test each bank the way it does. But it also is important for our shareholders to understand the difference between the Fed’s stress test and what we think actually would happen. Here are a few examples of where we are fairly sure we would do better than the stress test would imply:

• We would be far more aggressive on cutting expenses, particularly compensation, than the stress test allows. 

• We would quickly cut our dividend and stock buyback programs to conserve capital. In fact, we reduced our dividend dramatically in the first quarter of 2009 and stopped all stock buybacks in the first quarter of 2008. 

• We would not let our balance sheet grow quickly. And if we made an acquisition, we would make sure we were properly capitalized for it. When we bought Washington Mutual (WaMu) in September of 2008, we immediately raised $11.5 billion in common equity to protect our capital position. There is no way we would make an acquisition that would leave us in a precarious capital position. 

• And last, our trading losses would unlikely be $20 billion as the stress test shows. The stress test assumes that dramatic market moves all take place on one day and that there is very little recovery of values. In the real world, prices drop over time, and the volatility of prices causes bid/ask spreads to widen – which helps marketmakers. In a real-world example, in the six months after the Lehman Brothers crisis, J.P. Morgan’s actual trading results were $4 billion of losses – a significant portion of which related to the Bear Stearns acquisition – which would not be repeated. We also believe that our trading exposures are much more conservative today than they were during the crisis. 

Finally, and this should give our shareholders a strong measure of comfort: During the actual financial crisis of 2008 and 2009, we never lost money in any quarter. 

Bullish Long Term
And as usual, Dimon is bullish for the long term outlook of JPM's businesses.   Some of the long term macro drivers are:

No Split Part 2

Earlier in the report, he talked about how the JPM business model is driven by the needs of the customer, how size does not equate to risk, how large banks serve important needs (global, large clients etc).

And later in the report, he addresses the investor calls for a split-up:

Our long-term view means that we do not manage to temporary P/E ratios — the tail should not wag the dog  

Price/earnings (P/E) ratios, like stock prices, are temporary and volatile and should not be used to run and build a business. We have built one great franchise, our way, which has been quite successful for some time. As long as the business being built is a real franchise and can stand the test of time, one should not overreact to Mr. Market. This does not mean we should not listen to what investors are saying – it just means we should not overreact to their comments – particularly if their views reflect temporary factors. While the stock market over a long period of time is the ultimate judge of performance, it is not a particularly good judge over a short period of time. A more consistent measure of value is our tangible book value, which has had healthy growth over time. Because of our conservative accounting, tangible book value is a very good measure of the growth of the value of our company. In fact, when Mr. Market gets very moody and depressed, we think it might be a good time to buy back stock.

I often have received bad advice about what we should do to earn a higher P/E ratio. Before the crisis, I was told that we were too conservatively financed and that more leverage would help our earnings. Outsiders said that one of our weaknesses in fixed income trading was that we didn’t do enough collateralized debt obligations and structured investment vehicles. And others said that we couldn’t afford to invest in initiatives like our own branded credit cards and the buildout of our Chase Private Client franchise during the crisis. Examples like these are exactly the reasons why one should not follow the herd. While we acknowledge that our P/E ratio is lower than many of our competitors’ ratio, one must ask why. I believe our stock price has been hurt by higher legal and regulatory costs and continues to be depressed due to future uncertainty regarding both.

As I was reading this section (which makes a whole lot of sense), I was wondering what the investment bankers at JPM were thinking when reading this.  Imagine JPM bankers consulting a company on a potential split to enhance shareholder value, and the client says, "...but Jamie said that we shouldn't let the tail wag the dog!".


Consequences of Regulation
Dimon says that the banking industry is much safer and stronger than ever before and he is in favor of a lot of the new regulations.  But he does caution that there are consequences to some of this stuff, and it's a very interesting read.

For example, the markets are already feeling it a little bit:

Some investors take comfort in the fact that spreads (i.e., the price between bid and ask) have remained rather low and healthy. But market depth is far lower than it was, and we believe that is a precursor of liquidity. For example, the market depth of 10-year Treasuries (defined as the average size of the best three bids and offers) today is $125 million, down from $500 million at its peak in 2007. The likely explanation for the lower depth in almost all bond markets is that inventories of market-makers’ positions are dramatically lower than in the past. For instance, the total inventory of Treasuries readily available to market-makers today is $1.7 trillion, down from $2.7 trillion at its peak in 2007. Meanwhile, the Treasury market is $12.5 trillion; it was $4.4 trillion in 2007. The trend in dealer positions of corporate bonds is similar. Dealer positions in corporate securities are down by about 75% from their 2007 peak, while the amount of corporate bonds outstanding has grown by 50% since then. 

Inventories are lower – not because of one new rule but because of the multiple new rules that affect market-making, including far higher capital and liquidity requirements and the pending implementation of the Volcker Rule. There are other potential rules, which also may be adding to this phenomenon. For example, post-trade transparency makes it harder to do sizable trades since the whole world will know one’s position, in short order.  

Recent activity in the Treasury markets and the currency markets is a warning shot across the bow Treasury markets were quite turbulent in the spring and summer of 2013, when the Fed hinted that it soon would slow its asset purchases. Then on one day, October 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations – an unprecedented move – an event that is supposed to happen only once in every 3 billion years or so (the Treasury market has only been around for 200 years or so – of course, this should make you question statistics to begin with). Some currencies recently have had similar large moves. Importantly, Treasuries and major country currencies are considered the most standardized and liquid financial instruments in the world. 

He goes through a thought experiment on the next financial crisis which is very well worth reading. One of the issues is that regulation is driving some of the loans/financing outside of the banking system and that could cause problems in a crisis.  Banks will usually continue lending to support clients during a crisis, but non-banks may not, and this may exacerbate any crisis.

Anyway, that section is well worth reading as is the whole letter.

Oh, and here's a fun chart from the proxy statement.  We know Buffett is the cheapest laborer in the financial business, but Dimon comes pretty cheap too:

Conclusion
It's a pretty long report, as usual, at almost 40 pages, but it's really worth the read even for people not that interested in owning JPM.   You can't read a Dimon letter and not learn something.  So go ahead, what are you waiting for!?