The Secret of Big Banks

Email agenda:

Estimated read time: 6 minutes 22 seconds

1. Why banks like JP Morgan are getting crushed

2. Yield Curve 101 (super important)

3. Oh SNAP

4. My portfolio + Ethereum?

Good morning and happy Monday - let's get into the weeds

Big Banks vs Interest Rates

One of the main sectors that can sink or swim based on macro factors? Financial sector

JP Morgan, Bank of America, Goldman, etc

Banks make money from a variety of different ways including:

1. Investment banking fees (success based fees for advising on IPO’s, capital raise, M&A)

2. Lending fees

3. Investment gains

4. Card income

And various others. But their biggest source of income?

Net interest income

What is net interest income? The difference between the interest rate a bank pays to depositors or lenders (for their loans/debt) and the interest rate it receives from loans to consumers (you)

 Aka (interest income - interest expense)

Banks typically take out short term loans, and loan that money to you long term

Example: JP Morgan takes out a loan of $1m at 5% interest and loans it to you for 10 years at 8% interest

They collect the difference between the 8% - 5% as net interest income

So... what would make banks hurt? When the fed raises interest rates (remember the fed impacts short end of the yield curve, not the long end. I explain this in detail below)

So if they raise the 2 year interest rate and JP Morgan now has to pay more interest on the loan they took out than the interest on the loan they gave you…. Uhhhh ohhh

Now.. they aren’t making money

You can see below how big “net interest income” is on JP Morgan’s 2021 income statement below $52 billion out of $122 billion comes from net interest income or 43%

JP Morgan highlighted this as a risk to their business: If central banks introduce interest rate increases more quickly than anticipated, this results in a misalignment in the pricing of short-term and long-term borrowings

Yield Curve 101 (quick and simple version)

The yield curve is something you learn about in college econ and cannot wait to remove it from your brain

But... when I realized how important it is, I sucked it up and studied it again

Now I share the simple version with you

Normal Yield Curve

10th grade English: you earn higher yield (interest) the longer the maturity is on the fixed income instrument

4th grade: if you give Fred a loan for 10 years, you will charge him a higher interest rate than for 2 years, because there is more risk involved

Inverted Yield Curve

10th grade English: you earn higher yield (interest) are shorter maturity fixed income instruments 

4th grade: if you give Fred a loan for 10 years, you will LOWER him a higher interest rate than for 2 years

Short-end: The short end of the yield curve (left side of the graph) is impacted by central banks (i.e., buying and selling treasuries to raise rates)

When you hear on the news “the fed is raising rates” they are impacting the short end of the yield curve, not the long end

Long end: The long-end (right side of the graph) is impacted by GDP growth

So when the fed is raising rates, the short end of the curve gets pushed up, and as the GDP growth slows, the long end gets pushed down

^ This is not good

This is how you get the inverted yield curve that you see in orange above

Oh $SNAP!

Snapchat got pummeled last week after reporting earnings

When a company reports earnings, analysts from Goldman and other financial firms have "expectations", or put simply, what revenues and earnings they expect the company will have for the quarter or year

When a company reports their numbers, they either "beat analysts expectations", or "miss analysts expectations"

After they report their numbers, the management team is suppose to "guide"

This means they are giving guidance about what they expect numbers will look like in the future based on what they know now versus what they knew when they previously gave guidance

Example: "Our revenues for Q1 were $1m" <- reporting actual numbers "... but based on consumer demand, we believe our revenue in Q2 will be 15% higher than what we originally expected" <- guidance

Sometimes a company misses expectations, but provides guidance that they expect revenues to shoot up in the next quarter, and the stock will still go up

Snapchat missed earnings and wouldn't even provide guidance on future revenues or earnings

That's about as BEARISH as it gets

Jim Cramer "Buy Snapchat" - July 20, 2021

Shot:

Chaser:

Only down 84% since then Jim! Good call pal!

The hard truth is, people scroll Tik Tok, Instagram, and Facebook, so their ads can blend in and perform well with their platform

Nobody does that with Snapchat

What I am doing / not doing

I think one of the worst parts about the finance / investing industry is honesty and transparency, as I have said before

Some days or weeks, things don't go your way

Chinese equities which I am still bullish on due to their GDP accelerating had a rough week

I still own $CHIQ, $NIO, and will buy them on down days to play bullish China

My biggest position still remains the US Dollar $UUP

I am now buying bonds after avoiding them like the plague, ticker $LQD

I still have put options on commodities due to decelerating inflation 

Crypto

As I said in a previous newsletter, I will never try and pick the bottom

I am okay with missing some gains to make sure the price move isn't a "headfake" that baits you in and then smacks you across the face

With that being said, I still don't like Bitcoin here, but Ethereum is starting to look better

If Ethereum can have a good week this week, there's a chance it gets added to my portfolio (I won't be tossing a huge amount, potentially 0.25-0.50% of my capital)

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.