In early May the investing public learned that JP Morgan Chase lost over $2 billion on Credit Default Swaps, ironically a product that they helped to manufacture and distribute. More details begin to emerge each day, including that the investment bank lost $150 million alone on Friday May 11th and that shareholders have now filed a law suit against the bank. Since market participants have failed to recognize the substantial improvements to the economy and trading volume has declined as a result, investors and advisors have speculated that this could be the event that tips the economy back towards a recession. We tend to disagree with that theory.
JP Morgan Chase’s losses came from trading Credit Default Swaps (CDSs). These complex hedging instruments have great intentions on paper, but as the old saying goes “the road to hell is paved with good intentions.” Even though JP Morgan’s losses have surpassed $2 billion, CEO Jamie Dimon has publically stated that the investment bank is healthy and on pace for high revenues this fiscal year.
Despite the losses and the upset shareholders, this event is just that…an event. Some investors out of panic have feared that this could be the start of the next 2008 credit crisis and that JP Morgan may disappear tomorrow among a litany of other investment banks, much in the way Bear Stearns and Lehman Brothers did. The fact remains that the economy we are in right now is like night and day compared to 2008. During those troubling times we truly had a banking crisis…this is a case of a bank losing out on bad bets.
Time and time again we have written that events do not shape markets; long term economic trends shape markets. The DJIA did drop in value on May 11th largely in part of JP Morgan’s struggles, but this will not result in a long term market adjustment.
For day traders, JP Morgan’s problems could have some ramifications and will certainly make the markets slightly more volatile in the coming weeks. However for Main Street investors who are in it for the long haul, this is a non-event. There simply is too much positive news in the economy right now. Manufacturing continues to pour back to the US. Job openings are becoming more and more abundant (even if finding the right worker for the job is becoming more and more difficult). Corporations are sitting on billions upon billions of dollars in cash just waiting to put it to good use. New oil and natural gas discoveries within the US are appearing on a near monthly basis. Home builders are seeing more and more activity and existing residential real estate is beginning to turn over.
When analyzing the effects of JP Morgan’s recent losses, we need to look beyond the shock of today and in to the future. Ask yourself if this is an event that will shape the equity markets for years to come. Our guess is probably not. Be cognizant that the markets are not shaped by events, but rather by economics. Right now, the US equity markets are sitting pretty, and are set to improve as the economy expands.