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Market Recap – All Eyes On Deutsche Bank

Market Digest – Week Ending 9/30

It was a choppy week for markets. Both foreign and domestic stocks initially fell on worries surrounding Deutsche Bank’s financial health, but regained ground mid-week. They dipped again on Thursday when certain clients of Deutsche Bank started to reduce exposure, only to rebound the next day when news surfaced of a $5.4 billion settlement between the German lender and US Department of Justice. US bonds and the dollar were relatively flat, while gold was slightly down.

Weekly Returns:

S&P 500: 2,168 (+0.2%)
FTSE All-World ex-US: (-0.1%)
US 10 Year Treasury Yield: 1.59% (-0.03%)
Gold: $1,318 (-1.4%)
USD/EUR: $1.124 (+0.1%)

Major Events:

• Monday – Hillary Clinton and Donald Trump faced off, setting the record for the most watched presidential debate ever with 84 million viewers.
• Monday – August single family home sales fell 7.6% from a month earlier, slightly beating consensus estimates.
• Wednesday – US durable goods orders were flat in August, with weakness coming from energy firms pulling back on investment.
• Thursday – News surfaced that certain hedge funds and clients were reducing their exposure to Deutsche Bank over liquidity concerns.
• Thursday – US second quarter GDP was revised up to 1.4% growth.
• Friday – Rumors circulated that Deutsche Bank was nearing a $5.4 billion settlement with the US Department of Justice.

Our take:

It’s been a nasty year for European banks as they continue to face persistently weak economic growth. For one bank in particular, conditions have worsened. Deutsche Bank made headlines mid-September when the US Department of Justice proposed a $14 billion fine surrounding its selling of mortgage securities. Despite management saying it has no intent of settling anywhere near this figure, the news sent shares lower on fears it could impact the firm’s liquidity.

Volatility was further compounded on Thursday when news surfaced of several hedge funds and clients pulling funds and reducing trading activity with the bank. It is this second piece of news that’s particularly troubling. When it comes to financial institutions, the name of the game is confidence and trust. It becomes a very slippery slope when that confidence is shaken. We saw what can happen first hand in the financial crisis of 2008. It starts as rumors of insolvency and eventually becomes a self-fulfilling prophecy as more and more customers distance themselves, until finally the bank runs out of money.

To be sure, that’s not exactly what is happening with Deutsche Bank. At this point, the number of clients reducing exposure appears limited. And despite Chancellor Merkel’s somewhat hardline stance on bailouts, it’s hard to imagine a scenario where the German government allows Deutsche Bank to fail. The impact of such an event to the overall banking system would be too severe.

Moreover, news surfaced Friday that the company is nearing a $5.4 billion settlement with the US Department of Justice, sending shares sharply higher. If confirmed, this reduced amount would indeed be a welcomed development. It won’t, however, solve all of Deutsche Bank’s problems. It is still a large fine that will materially impact capital, and the European banking environment remains challenging. It will continue to be an uphill battle for Germany’s largest lender.

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