Financial shares skidded and rebounded in a roller coaster ride last week as investors tried to assess whether Deutsche Bank's (DB) financial woes could develop into larger systemic problems for financial institutions here and abroad.
Germany’s largest financial institution is attempting to negotiate down the U.S. Justice Department's proposed $14 billion settlement for its mortgage securities actions ahead of the financial crisis. The German lender was reportedly close to a $5.4 billion settlement deal.
Remember the Big Picture
In volatile trading environments, it is easy to get caught up in the fear and greed driven by news headlines and market zigzags. In these situations, according to JJ Kinahan, chief market strategist at TD Ameritrade, investors may be better served to take a step back and view the bigger perspective.
In his venerable Dow Theory, Charles Dow explains market movement in terms of oceans. Bull and bear markets are like tides, day-to-day movements are akin to ripples, and breakout trends are like the occasional big wave. Last week's Deutsche Bank news may have been a temporary ripple as banks, lenders and other financial companies continue to recover on Monday. But, don't get lulled into complacency.
- The Ripples Could Turn Into Waves. The story may not be over. It will have ebbs and flows, says Kinahan. "Think back 24 months to the same conversation about Greek banks and Italian banks. Usually, this takes a few weeks, if not months, to work through these situations.
- The world is interconnected. We live in an inter-related world, Kinahan says. "When you have a large bank in Europe that is in trouble, it will likely affect things in the U.S."
Sam Stovall, chief investment strategist of CFRA Research agrees. "One of the most dangerous phrases in investing is -- This area is decoupled from the rest of the world." That said, Stovall doesn't believe the current Deutsche Bank woes will be the start of another 2008. "Wall Street wants to quantify how much Deutsche Bank will be penalized, so they can move on."
Active Traders May See More Ripples Ahead: Watch Earnings
The financial sector has come under fire this year from numerous fronts, Kinahan notes. That includes the Deutsche Bank woes, concerns about fallout from the Wells Fargo scandal, in which bank employees opened two million accounts without the knowledge of its customers, and also delays from the Federal Reserve on interest rate hikes. "The markets had expected two or three interest rates raises by now," Kinahan said.
At the start of 2016, the Fed had projected as many as three or four interest rate hikes this year, but has yet to deliver even one. Banks and financial companies could benefit from rising interest rate environments if higher rates lead to larger profit spreads on lending activities.
"If you are in financials, be a little more on guard," Kinahan says. Get ready for third quarter earnings season, he says. "Pay attention to what they say on earnings calls about future prospects," Kinahan says.
Traders can circle October 14 on their calendar as one of the busiest days of financial earnings. TD Ameritrade clients can track upcoming earnings releases via the Calendar. See Figure 1 below.
How Can Investors Ride the Tide?
Long-term investors can best prepare for market ripples, waves and tides through a well-diversified portfolio, Stovall says. This means diversification not only through individual stock holdings but across asset classes as well. "This will allow investors to continue to invest for the long-term," Stovall concludes.