What we read in JP Morgan’s letter to shareholders?

10 Apr 2023 , 08:47 AM

Now, Jamie Dimon is the CEO of JP Morgan, one of the world’s most powerful banks and needs no introduction. He was one of the few bank CEOs would could navigate their banks safely through the financial crisis of 2008 and emerged stronger and sharper. In his letter to shareholders along the CY22 annual report, Jamie Dimon has spoken at length about how to be prepared for a banking crisis. Dimon underlined that the banking crisis may have been subdued, but was far from over.

2022, a rather abnormal year

Dimon starts with the axiom that the year 2022 was far from normal; either economically or geopolitically. There were several dramatic events that hit the world in 2022. This included the Ukraine war, inflation hitting 40-year highs, Fed embarking on the fastest pace of rate hikes and US unemployment rate falling to an unprecedented low of 3.4%. Dimon also adds that year 2022 saw US housing demand weaken after a very long time. In addition, there were repeated instances of inverted yield curves, when the short term bond yields were higher than the long term bond yields. This was also the first time when there had been repeated warnings of a recession from experts and economists but the US economy actually showed a sharp recovery in real GDP growth in the third and fourth quarters of 2022.

10 key points we read in the Jamie Dimon letter to shareholders

Dimon was emphatic through the newsletter that while the current economic situation in the US was comfortable, the storm clouds could not be ignored. Here are the takeaways.

1. Consumer spending has been robust and that has been a key factor in holding inflation up. For instance, consumers spent 7% to 9% more in CY2022 compared to CY2021 and 23% more than pre-COVID levels. Much of the consumption has been driven by wages going up sharply at the lower end of the wage spectrum.

    

2. Dimon underlines that the crisis in banks like SVB, Signature Bank and Credit Suisse had increased the probability of recession. This uncertainty is likely to slow spending. In the US, consumer spending still accounts for 65% of the economy and so a slowdown in spending could have larger macroeconomic consequences for growth.

    

3. The lag effect of fiscal stimulus is persisting even today. For example, the Federal deficit has been $3.1 trillion in 2020, $2.8 trillion in 2021 and $1.4 trillion in 2022. This money has ended up in consumer pockets, so inflation may be much tougher to contain this time. The deficit for next three years is estimated at $1.4 trillion to $1.8 trillion per year. As Dimon points out, the world has seen nearly 12 years of quantitative easing; a lot.

    

4. Dimon feels that the Quantitative tightening that the Fed started in June 2022 (better called taper) has led to reduction in the Fed balance sheet by $550 billion. However, the current pace is around $1 trillion per year so it would take a full 5 years to even bring the bond holdings of the Fed to pre-COVID levels. Inflation, driven by liquidity, was going to persist for much longer than the Fed currently anticipates.

    

5. On the Ukraine war front, Dimon has pointed out that the war in Europe complicates the economic equations. The Ukraine war has had major consequences for most European economies. More importantly, Dimon points out, that war was affecting global energy and food supplies, with a disproportionate impact on economically weaker classes. These shortages had already caused persistent food inflation in the last one year.

    

6. An interesting point made by Dimon is that the full implications of interest rate policy had not been appreciated and it could become a lot more critical in coming years. Dimon points out that persistently rising rates can have a deleterious impact on venture capital, real estate development and carry trade (borrowing short and investing long). All these 3 trends are already visible, but Dimon expects this impact to get more intense.

    

7. Dimon feels that recession may not happen in the US as expected. That is because, the inversion reflects QE, but the US is already into QT and likely to get very intense. Dimon also points out that inverted yield curves are driven by rising short term rates, but there is little control that Fed has over longer term rates. The good news is that the inverted yield curve in the US may not translate into a recession, after all.

    

8. Dimon sounds a warning that the global markets will have to be prepared for sharply higher levels of volatility. The quantitative tightening combined with rising rates and consumer spending still persistent, could result in a lot of uncertainty and confusion in the market. Clearly, the old models of economic thinking are not working and that is likely to add to the volatility in the bond and equity markets. Markets must be essentially prepared for a much higher level of VIX in the coming months.

    

9. It is quite clear that supply chains would get revamped in a substantial way. Dimon insists that when it comes to products or materials with national security implications, the preference must be domestic or friendly allies and partners. He also believes that there would and should be more of an effort in the US to offer protection to new age industries like green energy, EVs, lithium batteries etc. He also talks about the urgent need to diversify supply chain partners, rather than face the embarrassment of too much dependence on China. All these would mean huge shifts in the supply chain in the coming months and years.

    

10. Finally, Dimon is of the view that the real risks to the banking sector and the economies would come from a different level altogether and they would be a lot more complicated. For instance, geopolitical events, cyber-attacks, failure of digital infrastructure and dysfunctional markets may be a much bigger risk for the global markets. 

As Dimon sums it up in the letter to shareholders of JP Morgan, the focus for banks and other businesses in the coming years will be about risk. The differentiating factor will be how well they assess and manage the risk rather than the efforts to expand markets or boost revenues. That surely is going to be a lot more complicated than it appears to be.