Monday, August 31, 2009

Today’s heroes – Yesterday’s villains.

Last week Royal Bank reported record high earnings. In the twilight of Canada’s recession, Canada’s biggest, bluest bank surprised us all. Other banks experienced healthy profits too. Bank analysts and the financial press reported that the Canadian economy and the real estate/mortgage sector had not been as bad as they had been predicting – and this was why the banks reported such strong quarterly earnings. This, plus one other factor: trading revenues from investment banking and capital markets divisions.

Apparently 21% of Royal Bank’s record high earnings came from traders. And we all know that traders are paid salary + bonus. And, because those trading profits were so high, we can guess that those employees’ bonuses will be really high too.

Wasn’t it just seven short months ago that new president Barrack Obama expressed outrage at the bonuses being paid by the US banks he was bailing out? Even though the traders and managers had made money for the failing banks and had done their jobs, they didn’t deserve their bonuses. For those American banks late last year, the economy was weak and the real estate/mortgage sector was collapsing. Times were so bad that US banks were failing despite the traders’ having done their jobs. The traders’ bonuses were reduced because the mortgage department lost so much money.

We wonder how that problem was eventually resolved. Did the American banks’ traders get paid less? Or did they simply have those bonuses postponed until the banks became profitable again? Or did they quit their jobs in New York and join the Canadian banks in Toronto?

How the rules change in the investment business. What works one year may not work the next. It appears that rule-changing can also apply to people’s paycheques. Traders who had earned their bonuses in US banks in 2008 were financial villains who did not deserve to get paid. But Canadian traders in 2009 are financial heroes, helping propel Canadian banks back to blue chip status. Either way, their fate seems to have been determined by the mortgage department, not the trading department. Because Canadian banks’ mortgage departments were profitable, Canadian traders will have no trouble collecting their 2009 bonuses. Because American banks’ mortgage departments were a disaster in 2008, their traders were criticised for their ‘undeserved’ bonuses. This time around, American investment bankers and capital markets traders were somehow dependent on the bank’s mortgage portfolio for their bonuses.

How about your personal investment bank – or your personal capital market: do your advisors deserve a bonus? Most mutual funds investors pay management expenses of over 2% of the value of their investments. When your investments go down in value, you pay them 2% of that lower value. If your investments are down 30%, your mutual funds manager receives 30% less management fee. In a strange way, it almost seems fair; but it doesn’t feel fair. In fact, it feels outright unfair.

In the world of finance, feelings count. When the banks were being bailed out by the government, it didn’t feel right that bank employees would receive big bonuses, no matter how good a job they did. Now that the Royal Bank has proven to the world that Canadian banks are high quality blue chip banks, there is no problem paying those big bonuses.

In my book, Beyond the Bull: Taking Stock Market Wisdom to the Next Level, I discuss how our feelings affect our investments. In seven short months, banks have gone from presidential rebuff to examples of blue chip stability. And in those same seven months, Royal Bank stock went from under $30 per share to over $55. Your feelings count.

Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.

Links to Beyond the Bull:




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