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Shades of 2000 in digital bank initiative, Fed loosening

The rally in US stocks and the excitement around the issue of digital bank licences might not last

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The strong rally in US stocks over the last few months, and current giddiness in the start-ups space, is giving me a sense of deja vu. And, if history is any guide, it is probably time for investors to be wary.

THE strong rally in US stocks over the last few months, and current giddiness in the start-ups space, is giving me a sense of deja vu. And, if history is any guide, it is probably time for investors to be wary.

At the dawn of 2000, the Nasdaq was in the final stages of a parabolic ascent, and white-collar professionals were quitting well-paying jobs to join fledgling companies with big plans to seize all the new opportunities of the Internet era.

Then, as now, the US Federal Reserve was at least partly responsible for the bullishness. As 1999 drew to a close, the Fed flooded the market with liquidity, just in case the dreaded Y2K bug gummed up the banking system. However, Y2K was a non-event and the Fed's efforts gave the already red-hot technology sector a boost it did not need.

The Fed was in a similarly expansionary mode last year. It began reducing interest rates for the first time since the Global Financial Crisis, making three 25-basis-point cuts in the federal funds rate in total. The Fed has also been injecting huge amounts of cash into the financial system since September to quell signs of stress in the repurchase agreement market.

Against that backdrop, US stocks that already had lots of momentum behind them - like Apple and Alphabet - are now charting a similar trajectory as the Nasdaq market 20 years ago.

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Meanwhile, in the private equity market, companies with valuations of more than US$1 billion - dubbed unicorns because of their supposed rarity - have become increasingly common in recent years.

Much like the late 1990s, the story here is partly about new technologies displacing old business models, but also partly about the sheer amount of money looking to back potentially "disruptive" ventures.

Adding to the excitement

In Singapore, plans to dole out two full digital bank licences and three wholesale bank licences have only added to all the excitement this time around. The Monetary Authority of Singapore (MAS) has received 21 applications for digital bank licences - 14 of them for the wholesale bank licences and seven for the full bank licences.

How much higher will the market climb? Is the local banking sector about to be transformed by a bunch of technologically savvy newcomers?

Before I go any further, let me say that I am not a fintech expert, and I have no idea what the contenders for the digital bank licences plan to do.

However, after a couple of decades of watching the market, I have learned that the local banks are no pushovers, and they are capable of facing up to existential issues.

In the late 1990s, for instance, they were merging among themselves to become bigger and more resilient in the face of global competition. Indeed, that is why there are only three of them today - DBS, OCBC and UOB.

The local banks have also proven to have a strong hold over their retail customers. Through the 2000s, under the "qualifying full bank" licence programme, a handful of foreign banks - including ABN Amro, BNP Paribas, Citibank, Standard Chartered, HSBC and Malayan Banking - were afforded more flexibility to open branches, expand their ATM networks and tap CPF savings.

Yet, the three local banks still have a dominant position today in Singapore, and have developed significant regional footprints. Interestingly, DBS and UOB have also rolled out digital banks of their own outside of Singapore.

More to the point, disruptors do not disrupt by adopting the business model of the incumbents.

While a digital bank unburdened by legacy infrastructure may well be able to achieve lower operating costs and deliver a better customer experience, it might not succeed in building a profitable business if it doesn't completely win the trust of depositors and develop sufficient scale. And, over time, its technological edge could well be replicated by the bigger players.

To be clear, I am not suggesting that the established banks are immune to disruption, but that they are unlikely to face disruption at the hands of competitors with the same business model and that are subject to the same regulations.

Moreover, disruptors need to have the capacity to outlast the buoyant market sentiment that gets them off the ground. Until that happens, there is a fine line between opportunism and innovation. While banking as we know it may eventually become obsolete, its real nemesis may not emerge until the current boom has long turned to bust.

Lessons from the FAANGs

The experience of the FAANG companies - Facebook, Amazon, Apple, Netflix and Google (which is owned by Alphabet) - provides some basis for these assertions.

The FAANGs are arguably the best known disruptors in the public-listed space, but they have very different business models than the traditional retailing, telecommunications and media companies to which they have laid waste.

Also, the FAANGs today are not all defined by the moves they made during the heady 1990s. For instance, Netflix was founded in 1998, but its main business at the time was renting out DVDs by mail.

It didn't roll out its streaming media business until 2010. Steve Jobs returned to Apple in 1997, but it wasn't until 2007 that he unveiled the first iPhone. Mark Zuckerberg had not even written the software for FaceMash, the forerunner of Facebook, until 2003, well after the technology bubble had burst. It remains to be seen if the digital bank aspirants have what it takes to thrive through the market cycles.

So, what should investors do? It is probably a good idea to tread carefully with the heavyweight stocks that have led the market higher over the last few months - including some of the FAANGs. There could well be a correction analogous to the sell-off that followed the liquidity-fuelled rally through 1999 and into 2000.

The correction might also be accompanied by bad news, like slowing economic growth and a worsening of US-China trade relations. But don't panic. As it has demonstrated repeatedly over the last two decades, the Fed is always prepared to step in when the going gets really tough.

  • Mark to Market is a new weekly column offering analysis and insight on market trends and corporate issues.

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