This is a perfect example of how risky big banks are and why they usually have low PE ratios. Due to the complexity of their business, you never know where a black swan might emerge from (black swan – an event that deviates from what is normally expected and is extremely difficult to predict). Shares of DB were trading above $100 per share prior to the financial crisis and strongly above $50 afterward until several black swans hit it.
The latest bad news came from the Department of Justice and its proposed $14 billion settlement for DB’s trading activities in the financial crisis which DB’s CEO rejected. On top of such—and other scandals—in June 2016, the International Monetary Fund issued a warning that DB appears to be the most important net contributor to systemic risks. The same report states that the largest German banks and insurance companies are highly interconnected which explains why the complete European market moves in line with bad news for DB.
But all of the above was well known before this Monday when DB stock fell 7%. The most recent fall was influenced by the German Chancellor’s words that it will not bail out DB in case of trouble. DB quickly replied that it did not ask nor it will be needing government aid, but the damage was done.
Apart from the insight of how risky banks are, what can also be understood from the story above is how dependent markets are on government and financial institutions. Last Wednesday, the FED didn’t increase interest rates which pleased the markets but as soon as the weekend came, markets fell as the German government said that it will not bail out DB.
Investors will be better off avoiding such artificial markets as sooner or later those markets return to normalcy, or worse. As they are artificially inflated, when the strong government hand removes itself, panic will kick in and send asset prices to artificially low levels like they were in 2009.
On Monday, the DAX index (Germany) fell by 2.29%, and the S&P 500 also fell more than 0.8%. It’s clear that some contamination is unavoidable. But this has much larger implications than just a daily drop in stock prices. The economies are interconnected and trouble in one bank, like the Deutsche Bank, can be a trigger of systemic risks. Therefore, even if the U.S. economy does well and the FED does everything right, there is always the risk of contamination from Europe.
What should you do when the risks seem to be everywhere? The world will continue to spin even if there is a recession or a bankrupt financial institution. Demand for commodities will grow alongside global population growth, and the best companies will find a way to reach their customers. Two things are important: find good companies that will do well in any environment, and have some cash available that will give you the opportunity to buy when things get cheap.