It’s been almost 10 years in the making, but the fate of one of Europe’s most important financial institutions appears to be sealed. After a hard-hitting sequence of scandals, poor decisions, and unfortunate events, Frankfurt-based Deutsche Bank shares are now down -48% on the year to $12.60, which is a record-setting low. Even more stunning is the long-term view of the German institution’s downward spiral. With a modest $15.8 billion in market capitalization, shares of the 147-year-old company now trade for a paltry 8% of its peak price in May 2007.
The Beginning of the End
If the deaths of Lehman Brothers and Bear Stearns were quick and painless, the coming demise of Deutsche Bank has been long, drawn out, and painful. In recent times, Deutsche Bank’s investment banking division has been among the largest in the world, comparable in size to Goldman Sachs, JP Morgan, Bank of America, and Citigroup. However, unlike those other names, Deutsche Bank has been walking wounded since the Financial Crisis, and the German bank has never been able to fully recover. It’s ironic, because in 2009, the company’s CEO Josef Ackermann boldly proclaimed that Deutsche Bank had plenty of capital, and that it was weathering the crisis better than its competitors. It turned out, however, that the bank was actually hiding $12 billion in losses to avoid a government bailout. Meanwhile, much of the money the bank did make during this turbulent time in the markets stemmed from the manipulation of Libor rates. Those “wins” were short-lived, since the eventual fine to end the Libor probe would be a record-setting $2.5 billion. The bank finally had to admit that it actually needed more capital. In 2013, it raised €3 billion with a rights issue, claiming that no additional funds would be needed. Then in 2014 the bank head-scratchingly proceeded to raise €1.5 billion, and after that, another €8 billion.
A Series of Unfortunate Events
In recent years, Deutsche Bank has desperately been trying to reinvent itself. Having gone through multiple CEOs since the Financial Crisis, the latest attempt at reinvention involves a massive overhaul of operations and staff announced by co-CEO John Cryan in October 2015. The bank is now in the process of cutting 9,000 employees and ceasing operations in 10 countries. This is where our timeline of Deutsche Bank’s most recent woes begins – and the last six months, in particular, have been fast and furious. Deutsche Bank started the year by announcing a record-setting loss in 2015 of €6.8 billion. Cryan went on an immediate PR binge, proclaiming that the bank was “rock solid”. German Finance Minister Wolfgang Schäuble even went out of his way to say he had “no concerns” about Deutsche Bank. Translation: things are in full-on crisis mode. In the following weeks, here’s what happened:
May 16, 2016: Berenberg Bank warns that DB’s woes may be “insurmountable”, noting that DB is more than 40x levered. June 2, 2016: Two ex-DB employees are charged in ongoing U.S. Libor probe for rigging interest rates. Meanwhile, the UK’s Financial Conduct Authority says there are at least 29 DB employees involved in the scandal. June 23, 2016: Brexit decision hits DB hard. The bank is the largest European bank in London and receives 19% of its revenues from the UK. June 29, 2016: IMF issues statement that “DB appears to be the most important net contributor to systemic risks”. June 30, 2016: Federal Reserve announces that DB fails Fed stress test in US, due to “poor risk management and financial planning”.
Doesn’t sound “rock solid”, does it? Now the real question: what happens to Deutsche Bank’s derivative book, which has a notional value of €52 trillion, if the bank is insolvent? on Last year, stock and bond returns tumbled after the Federal Reserve hiked interest rates at the fastest speed in 40 years. It was the first time in decades that both asset classes posted negative annual investment returns in tandem. Over four decades, this has happened 2.4% of the time across any 12-month rolling period. To look at how various stock and bond asset allocations have performed over history—and their broader correlations—the above graphic charts their best, worst, and average returns, using data from Vanguard.
How Has Asset Allocation Impacted Returns?
Based on data between 1926 and 2019, the table below looks at the spectrum of market returns of different asset allocations:
We can see that a portfolio made entirely of stocks returned 10.3% on average, the highest across all asset allocations. Of course, this came with wider return variance, hitting an annual low of -43% and a high of 54%.
A traditional 60/40 portfolio—which has lost its luster in recent years as low interest rates have led to lower bond returns—saw an average historical return of 8.8%. As interest rates have climbed in recent years, this may widen its appeal once again as bond returns may rise.
Meanwhile, a 100% bond portfolio averaged 5.3% in annual returns over the period. Bonds typically serve as a hedge against portfolio losses thanks to their typically negative historical correlation to stocks.
A Closer Look at Historical Correlations
To understand how 2022 was an outlier in terms of asset correlations we can look at the graphic below:
The last time stocks and bonds moved together in a negative direction was in 1969. At the time, inflation was accelerating and the Fed was hiking interest rates to cool rising costs. In fact, historically, when inflation surges, stocks and bonds have often moved in similar directions. Underscoring this divergence is real interest rate volatility. When real interest rates are a driving force in the market, as we have seen in the last year, it hurts both stock and bond returns. This is because higher interest rates can reduce the future cash flows of these investments. Adding another layer is the level of risk appetite among investors. When the economic outlook is uncertain and interest rate volatility is high, investors are more likely to take risk off their portfolios and demand higher returns for taking on higher risk. This can push down equity and bond prices. On the other hand, if the economic outlook is positive, investors may be willing to take on more risk, in turn potentially boosting equity prices.
Current Investment Returns in Context
Today, financial markets are seeing sharp swings as the ripple effects of higher interest rates are sinking in. For investors, historical data provides insight on long-term asset allocation trends. Over the last century, cycles of high interest rates have come and gone. Both equity and bond investment returns have been resilient for investors who stay the course.
