What You Don’t Know About Banks Will Hurt You

bank stocksThe latest revelation that JPMorgan Chase & Co. (NYSE/JPM) suffered a multi-billion loss on bad investments is yet another warning sign that bank stocks are littered with questionable trades that the average person simply can’t decipher. The investment strategy developed by bank stocks over the past decade has been questionable at best. The strategy of taking excess liquidity and using those funds in an investment strategy to enhance earnings, which then leads to higher bonuses, has littered the bank stocks with billions in losses over the past decade.

bank stocks

Chart courtesy of www.StockCharts.com

JPMorgan estimates that, while it tries to unwind the position, it will cost an additional $1.0 billion. I’ve actively traded around several large blowups due to bad trades, such as Amaranth Advisors, and things get far worse before they get better. Amaranth Advisors was a huge player in the natural gas markets. As its investment strategy started going south, everyone on the street smelled blood in the water. This exacerbated the company’s losses, as its positions got squeezed. Amaranth ended up losing over $5.0 billion in one week, with the entire firm shutting down shortly after with losses well in excess of $6.5 billion, out of total asset size of $9.0 billion.

This is similar to legendary hedge fund manager John Paulson. His firm, Paulson & Co., was squeezed out of his investment strategy in being long gold during the fall of 2011. The street got wind of his investment strategy and proceeded to squeeze him, forcing even larger losses that snowballed into more selling.

The street is extremely smart in figuring out large players and their respective investment strategy. No one firm can control a market for long. Eventually, the Street will squeeze them out. JPMorgan’s unit has in excess of $200 billion, so a $2.0-billion loss is not a huge amount relatively speaking. But, for bank stocks, this is a worse-case scenario, as more regulatory pressure will be forced onto them as outrage rises.

Frankly, I think there might be an opportunity to look at JPMorgan, but only once it is out of its position. The firm is still one of the largest and most profitable bank stocks, but it will take most of this year to unwind its investment strategy, and I also believe more losses will come. I would look to the late fall or winter, as bank stocks might perform poorly during the September-October period. If we get more news of losses, but JPMorgan also announces it is out of this investment strategy, then that might perhaps signal a long-term bottom. There is, however, a long time to go between then and now. For the time period, I would not invest in bank stocks until the dust settles, which might not happen until early next year.