Regardless of which side of the political aisle you're on, it's safe to say that the current presidential administration is different than any we've seen in modern history -- perhaps going as far back as Andrew Jackson in the first half of the 1800s, a comparison that Donald Trump himself has made.
Much of the difference is the media attention surrounding Trump's presidency. This creates noise and uncertainty in the markets that can be both a threat and an opportunity for savvy investors. But there are also substantive issues on the table -- be it the promised regulatory rollback, a potential trade war, tax cuts, or increased spending on infrastructure.
This has led me to rethink the traits that investors should be looking for in potential investments right now. With respect to bank stocks, my focus area, this has convinced me that JPMorgan Chase (NYSE:JPM) may be the best bank stock to own during Trump's presidency. An investment in the $2.5 trillion bank allows investors to simultaneously play offense and defense, both of which are likely to be important strategies over the next few years.
A broad range of outcomes
Like Andrew Jackson, Trump has vowed to shake up Washington -- to "drain the swamp." He wants to reduce regulations by 75%, erect protectionist trade policies, and embrace large fiscal policies that were long the province of the Democratic party.
The range of potential outcomes from all of these is wide. Things could turn out great, particularly if the White House is able to usher through the promised fiscal stimulus that will help jump-start the economy -- a connection that John Maynard King first made after living through the Great Depression. But things could also turn out horribly, as they did during Jackson's presidency when he ignited an economic depression by shuttering the country's central bank.
Prudent investors will want to hedge against both possible outcomes. And the best way to do that in the context of bank stocks is by owning shares of JPMorgan Chase.
Fragile by design
It's important to keep in mind that banks are fragile by design, which just so happens to be the title of one of the best books written about the industry over the past decade.
Banks are fragile because they operate with an enormous amount of leverage, borrowing around $10 for every $1 or so worth of capital. And because most of their debt consists of deposits, it's callable at any time. When people and companies think their bank is having problems, they can just empty their accounts en masse.
This is why banks tend to fail not for want of capital but rather for want of liquidity. It was a bank run in 1984 that brought down the first too-big-to-fail bank, Continental Illinois, one of the largest banks in America at the time. It's also what caused Bear Stearns to come within a hair's breadth of failure in 2008. "For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured funding, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed," observed then-SEC Chairman Christopher Cox.
The banking business is no favorite of ours [at Berkshire Hathaway]. When assets are twenty times equity-a common ratio in this industry-mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.
Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.
The good news for bank investors today is that a number of the nation's biggest banks fit this description. Bank of America (NYSE:BAC) offers a case in point. It has more capital than any other bank in the country, which would insulate it from even extraordinary loan losses if the economy were to descend into a policy-induced depression as was the case during Jackson's presidency. Bank of America's shares also trade for a 4% discount to its book value, a seemingly reasonable valuation when you compare it to the 45% premium for the average large-cap bank stock.
But the downside to Bank of America is that its leadership throughout the years hasn't demonstrated the same degree of prudence that's necessary to maximize returns through all stages of the credit cycle. It almost failed in the 1970s when it was known as NationsBank. Another of its predecessor companies, the eponymous Bank of America, nearly closed up shop in the 1980s. And a decade after these two institutions came together at the end of the 1990s, they almost went down together in the financial crisis.
Another bank that fits the description is Wells Fargo (NYSE:WFC), the second-largest position in Berkshire Hathaway's investment portfolio. Buffett has even gone so far as to say that Wells Fargo would be the stock he'd buy if he had to invest his entire net worth into only one company. The California-based bank has long been one of the most profitable big banks in the country. Moreover, with the exception of its recent fake-account scandal, it's done so in an especially prudent manner.
Wells Fargo didn't just survive the financial crisis. It thrived through it, more than doubling in size due to its bargain-basement acquisition of Wachovia in 2008. As Wells Fargo's chairman and CEO at the time explained in their 2007 shareholder letter:
Because of our prudent lending to customers with less than prime credit and our decision not to make negative amortization loans, we estimate we lost between two and four percent in mortgage origination market share from 2004 to 2006. That translates into losing between $60 billion and $120 billion in mortgage originations in 2006 alone. We're glad we did. Such lending would have been economically unsound and not right for many borrowers.
However, the downside to Wells Fargo is that it's in the midst of a transformation that, by its new CEO Tim Sloan's own admission, will lower its long-term growth rate. And its stock isn't cheap, trading as it does for a 62% premium to book value.
This leaves JPMorgan Chase
Among the biggest banks in the country, this leaves JPMorgan Chase as the one that currently best fits Buffett's suggestion to focus on "well-managed banks [trading] at fair prices." This is ironic because Buffett has never added JPMorgan's stock to Berkshire Hathaway's portfolio. Yet, he does own it in his personal stock portfolio, routinely praises its CEO Jamie Dimon, and the Oracle of Omaha has even allowed one of his lieutenants at Berkshire Hathaway to join JPMorgan's board of directors.
There's simply no question but that JPMorgan Chase is one of the best-managed banks in the country. By all accounts, Dimon is this generation's finest banker. He's experienced, brilliant, savvy, and unusually prescient. In his 2006 shareholder letter, for instance, which I discuss at length here, while Dimon's peers at Bank of America and Citigroup (NYSE:C) lauded their strength and desire to continue growing, Dimon sounded a near-apocalyptic warning:
We do not know exactly what will occur or when, but we do know that bad things happen. There is no question that our company's earnings could go down substantially. But if we are prepared, we can both minimize the damage to our company and capitalize on opportunities in the marketplace.
It was this prescience that convinced Dimon to offload JPMorgan's subprime mortgage exposure well before Citigroup, Bank of America, and others simultaneously rushed to follow suit. As such, it was also this prescience that positioned JPMorgan Chase to buy not one but two major competitors for pennies on the dollar during the financial crisis. It bought Bear Stearns in March 2008 and acquired the vast depository base of Washington Mutual six months later.
Author and commentator Nassim Taleb has termed this quality "antifragile," the ability to gain from chaos as opposed to flounder in it. But whatever term you prefer, the fact of the matter is that JPMorgan Chase used the opportunity to emerge from the crisis as the biggest bank in America, hurdling over longtime industry darlings Citigroup and Bank of America. And further sweetening the pot for investors today is the fact that JPMorgan's stock trades for only 34% over book value, which amounts to a discount relative to the average large-cap bank stock.
At the end of the day, then, investors in JPMorgan Chase are left with a banking franchise that's both prudently managed and reasonably priced, as well as a franchise that's uniquely positioned to profit from any positive developments that may come its way in the form of higher interest rates, a revived economy, or relaxed regulations. In sum, if you're looking for the best bank stock to own during Trump's presidency, JPMorgan Chase seems to fit the bill.