As Congress exits tomorrow for its five-week summer recess, Washington will stay in front of investors, and besides mixed signals about the prospects of going off the fiscal cliff, you can bank on more reasons to stay away from U.S. banks.
Two events over the past week have made cliff assessments more difficult. First, the Republican House and Democratic Senate agreed, nearly 60 days early, to fund the government for six months after the Oct. 1 start of Fiscal 2013. This will remove the threat of a government shutdown in December, when members and the White House will otherwise be negotiating whether and how to extend the Bush tax cuts and obviate a $100 billion hit to discretionary defense and nondefense spending accounts. This could lead both sides to take a harder line before and after the elections.
Meanwhile, the Obama Labor Department's July 31 announcement that defense companies should refrain from giving early notice of potential layoffs suggests that Obama wants to soft pedal the threat before the elections, then leverage it in December to try to force Republicans into a tax-raising mini-grand bargain. The net effect could be to strengthen Obama's post-election hand, should he win a second term, and may help him to do that as well. And with defense primes Lockheed-Martin (LMT), Raytheon (RTN) and Northrop (NOC) all up 10% plus over the past year, despite such worries, investors' imperviousness to scary noise from Washington could finally be put to the test.
Separately, a next shoe to drop in the card interchange wars could be an effort on the part of some large retailers to torpedo the recently negotiated class action settlement. Target (no pun intended): to raise the level of dissenters to the 25% threshold at which point Visa (V) and MasterCard (MA) could feel compelled to pull the plug. Given large merchants' reservations about the deal legally insulating many current card industry practices over the next 10 years, we're hearing that it's just a matter of time before Sen. Dick Durbin (D-Ill.), the big box retailers' best friend, will take to a mike to bash the agreement as a raw deal.
We'd still bet that the settlement will go forward. Nevertheless, card company and network investors have become conditioned to duck whenever Durbin rattles sabers.
Elsewhere, even as the House has held two hearings on mobile payments, repeated focus on the fact that 85% of transactions still come via cash and checks mean massive opportunity. While the card-issuing banks and networks will face cost- and convenience-related challenges from non-traditional/non-bank competitors, the banks are acting most threatened, clear in the protectionist tone of recent testimony from The Clearinghouse Association.
Clearly mobile payments and Near Field Communications (NFC) technology have huge potential, but they could also pose a challenge to the conduct of the Fed's future monetary policy. And while the powers that be may favor today's incumbents -- and banks may be best positioned to win in a race toward a new open wallet regime, anyway, due to consumer trust and capital available to invest -- they are worried that payments made via cell phones could eventually represent a disintermediation threat.
Meanwhile, though both parties talk glowingly of the potential for mobile payments to spread, a telecommunications-policy parallel (Republicans' defense of local exchange carriers in the Net Neutrality dispute) would suggest that Democrats might be more supportive of unfettered innovation.
All of this would seem to make the prospective outcome of an Obama reelection and retained Democratic Senate (our 55% Blue Stock forecast) a good thing, long term, for online consumer-to-consumer auction company eBay (EBA) (which owns Pay Pal), for instance, while a Romney win and rightward realignment might help the banks. We would add more traditional online retailers and card networks as Red Stocks, too, as Durbin's advocacy of Internet tax legislation and his anti-lender and anti-card-company rhetoric would seem less threatening were he to become the Senate minority leader in the next Congress.
Finally, the Justice Department last week signaled that it will make indictments before October against traders at perhaps several more banks in the budding LIBOR rate-setting scandal. That worrisome story began with the $200 million Barclay's settlement announced on June 27. Not clear is how many of a couple of dozen initially-targeted traders will be cited, nor whether a U.S. bank will be in the mix. In any event, the prospect of perp walks that will help Obama finally look tough on big banks and Wall Street -- just weeks before the election -- might have both political and investment impact.
Specifically, even amid the hope of better days ahead should Republicans sweep, there are at least two reasons why that optimism might be premature. What if Romney, bearing scars from Bain-related attacks, still trailing in post-convention polls and watching Obama finally quench the political left's thirst for Wall Street blood -- decides to spring his own October surprise, perhaps during or just before a presidential debate? What if that might lead Romney to say he agrees with Sandy Weill's recent prescription that "it's time to break up the big banks?" That would create odds of near a tossup that forced down-scoping could be in prospect, hurling yet another blow at bank stock valuations.
Separately, a GOP sweep might be a mixed bag for another reason. While the immediate post-election reaction might be positive for investors, as the path toward avoiding the $100 billion budget sequester and $440 billion of 2013 tax increases would seem clearer, it would also be seen as a mandate for the U.S. to renew its path toward fiscal austerity. And as a top banking PM reminded me last week, the recent history in Europe has shown that that usually doesn't go well for the banks either.
For these reasons, investors eyeing the bank stocks, after past bottoming signals have proven false, might need to wait still longer.