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JPMorgan Chase & Co. (NYSE:JPM) recently reported earnings. As the largest bank in the U.S., we can use the company’s earnings call to look for clues as to how the economy is doing and whether or not a recession is coming.
Economic Clues
With persistent inflation and the yield curve inverting recently for a brief period of time, calls for a recession have become louder. The truth is, a recession will always be on the way, it’s simply part of the business cycle. However, what we want to try and figure out is when a recession will occur. For example, there’s no point in preparing now for a recession that might be a few years away. Therefore, what clues did JPM’s earnings give us?
To begin with, it appears that the consumer is actually quite strong. Consumer deposits increased 18% year-over-year and 4% quarter-over-quarter. Let’s take this in for a minute. In 2021, consumers spent a lot of money because of the government stimulus and from the economy reopening. Furthermore, in the first quarter of 2022, we have seen inflation spiral out of control – especially on essential items like food and energy.
Nevertheless, consumers actually had more money at the end of this wild quarter than they did a year ago and in the prior quarter. Interestingly, not only were deposits higher but so was spending. Combined credit and debit spending was up 21% year-over-year. This was mainly attributable to dining and traveling. In addition, client investment assets also increased 9% year-over-year, despite experiencing one of the worst first quarters for the stock market.
However, there were some negatives that we should also pay attention to. First off, consumer card debt increased by 11%. In addition, higher interest rates have impacted the company’s home lending revenue, which was down 20% from last year. Home lending originations also fell by 37%.
So, what does all of this tell us?
Well, it could be said that consumers are becoming more stretched because card debt increased by 11%. However, given the fact that deposit growth has outpaced debt growth, we would argue the opposite. We believe that consumers are so strong that they are willing to take on more debt because they want to spend even more.
Moreover, the categories that are leading the spending tell us a lot as well. As already mentioned, dining and traveling were the drivers of credit and debit spending increases. This suggests that consumers are now beginning to shift away from product purchases in favor of services purchases.
More specifically, consumers want fun experiences, which is understandable as everyone wants to return to the pre-pandemic normal. Therefore, it will be interesting to see if this trend continues going forward because it would indicate that services companies will be poised to benefit.
This type of spending could be boosted further by the increase in client assets. When investors see their assets increase in value, they are more likely to spend because they feel wealthier. Indeed, it appears that the Federal Reserve has been trying to limit this wealth effect by cooling down the markets with its hawkish rhetoric in hopes of reducing inflation, although it doesn’t appear to be working.
However, the decreased home lending origination might be a sign of a slowdown in the real estate market. Undoubtedly, if mortgage rates continue to increase, then the demand for real estate will fall as fewer buyers will qualify for mortgages. Given that real estate makes up a huge chunk of most people’s wealth, a slowdown here will likely achieve the Fed’s goal of reducing the wealth effect.
Nevertheless, in the short-to-medium term, the economy is strong and firing on all cylinders. JPM’s CEO, Jamie Dimon, appears to believe the same thing, as he had the following to say:
What I have pointed out in my letter is very strong underlying growth, right now, which will go on. It’s not stoppable. The consumer has money. They pay down credit card debt. Confidence isn’t high, but the fact that they have money, they’re spending their money. They have $2 trillion still in their savings and checking accounts, business is in good shape. Home prices are up. Credit is extraordinarily good. So you have this — that’s one factor. That’s going to continue in the second quarter, third quarter. And I — after that, it’s hard to predict.
As Jamie Dimon noted, there is strong underlying growth that he claims is not stoppable. He notes how consumers are spending but are also paying down their credit card debt. This is despite the fact that confidence isn’t high, but is likely driven by the desire to enjoy experiences as we return back to normal. Nonetheless, Jamie Dimon is clear to specify that his belief applies to the next two quarters as anything beyond that is too difficult to predict.
This is consistent with our belief that we are entering a mid-cycle slowdown. As we noted in one of our previous articles, we don’t believe a recession is likely to happen this year because the 3-month and 10-year treasury yields have not yet inverted. Thus, until that happens, we don’t believe we are in a late-stage bull market.
Is JPMorgan Chase a Buy?
Now that we’ve established that the clues in the earnings call point more favorably towards continued growth, should investors buy JPMorgan Chase? With interest rates expected to continue increasing, the bank will be able to earn more money on its deposits. It’s also generally believed that higher rates equate to higher net interest margins.
Surprisingly though, that isn’t always the case. As we’ve highlighted in a previous article about The Toronto-Dominion Bank (TD), the opposite tends to be true most of the time. However, we also noted that during the last rate hike cycle, net income margins did actually increase with higher interest rates.
We believe that the likely reason for this was attributable to interest rates being near zero. Thus, banks went from earning almost nothing on deposits to over 2%. Given the similar circumstance of raising from a base of zero, it’s likely that the banks will experience a rise in net income margins this time as well.
However, the bank is likely to face a lot of headwinds. To begin with, there is a slowdown in home lending which we already touched on earlier. Furthermore, despite auto loans increasing 3% year-over-year, originations fell 25% due to a lack of supply.
It’s likely that the supply won’t get much better this year, but the price of vehicles has shown signs of slowing down. In the March CPI, the price of new vehicles increased by 0.2% month-over-month while the price of used vehicles fell by 3.8%. Therefore, if prices fall while inventory remains low, JPM won’t see much growth from auto loans.
Valuation
To value JPM, we will use a very simple method to determine what the justified price-to-earnings ratio should be. First, we need to determine the stock’s discount rate. We will take the figure found on Finbox which is currently 7.4%. Next, we will use the following formula:
1 / discount rate = justified P/E
1 / 0.074 = 13.5x
Assuming no growth in earnings, the justified P/E ratio is 13.5x. With the stock trading at around 11.5x forward earnings, we can say that the stock is undervalued. If you include growth, then the justified P/E will be even higher.
Final Thoughts
JPM’s earnings call has highlighted to us that the consumer is still strong and expected to continue spending at least for another two quarters.
Thus, it seems unlikely that a recession will occur in 2022. However, some lending activity has slowed down in the past quarter and may continue to be slow due to higher interest rates.
Furthermore, although the stock is undervalued, it is currently on a downtrend that may have some more downside to go. As a result, we rate JPM stock as a Hold.
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