While Standard Chartered has never been considered a top-tier bank, it’s still a significant lender on the global scene. Shares in the bank took another tumble this week after its bottom line was hit by restructuring charges and rising bad loans. In total, Standard Chartered made its first annual net loss since 1989 with a deficit of $2.2 billion, versus a profit of $2.7 billion the previous year. After making it through the Financial Crisis relatively unscathed, the bank has finally been undone by its massive exposure to commodities and emerging markets more generally.The company’s stock is now down -30% YTD, -50% Y/Y and -75% from its 2013 high. At £415 a share Standard Chartered is trading at just 32% of book value. It’s hard to short a company at such distressed levels, but what if you were given the option to sell these same shares today at £1,000? Obviously you’d take that all day, right? That’s essentially what’s being offered in emerging markets right now, via EEM currently $30 a share. The chart below shows Standard Chartered against the MSCI EM index, not EEM, but that’s only because EEM launched in 2003 and wouldn’t show strong correlation dating back to 1990. If the correlation holds this time, EEM will be trading at $15; possibly soon.
A lot of investors are now aware of the risks facing emerging markets. However, few appreciate that EEM seems destined to go well below its 2008 low, and what the implications of that are. The chart of EEM versus the CRB Commodity index tells a very similar tale. The earnings announcement from Standard Chartered could be the flare that draws everyone’s attention to this possibility, but it might not. Even though the vast majority of its exposure comes from Asia, Standard Chartered is based in London, and investors could lump it in with Deutsche Bank, Credit Suisse, etc.
The other question is: what does this mean for Chinese banks? In terms of total assets, Standard Chartered is the 44th largest bank in the world. China is home to the world’s four largest banks and HSBC, domiciled in London but headquartered in Hong Kong, is fifth. These banks have lent money almost exclusively in Asia, and aren’t more conservative than Standard Chartered. In all likelihood we’ll never know the real non-performing loan numbers coming out of China, because the government will just paper it over. But that doesn’t mean the stress in the system isn’t real. Asian economies are slowing, loans (particularly those funded in USD) will go bad, and the local stock markets will suffer.
We know that this is all derived from USD, and the dirty secret is that USD isn’t down as much as stock market bulls would like. There was a big positioning washout earlier this month, but the fundamentals don’t justify significant depreciation. FX is a relative value market and all these countries are trying to devalue simultaneously. Which leaves global currencies like gold and Bitcoin as the beneficiaries, and it’s no surprise they’re both rallying this week.
The Cup & Handle Fund is up around +3.5% YTD, and +12.0% Y/Y. The portfolio has been very quiet recently; up days and down days but no real movement in either direction. Added some OTM options yesterday that should finish the year much higher and it’s always nice to buy volatility with VIX below 20 these days. Being a short month I’ll start working on our March letter soon, but no ETA as of yet. If you’d like to start receiving these letters click here.
With that I give you this week's letter:
As always, if you have any questions or comments or just want to vent, please send me an email at firstname.lastname@example.org.
Until next time, tread lightly out there,
Managing Editor – Cup & Handle Macro