John P. Swift, CFA, CPA Chief Investment Officer
312-259-9595 or firstname.lastname@example.org
May 18, 2020
One thing you want to see in a bullish-minded market is a bullish-minded performance from the bank stocks. That is not happening right now, and we will take a closer look at this “canary in the coal mine” industry.
A Brief History of Time
Back on March 23rd the Federal Reserve said it would buy Treasury and agency mortgage-backed securities in the amounts needed “to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” At that time, the Fed also announced the establishment of the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility, a Term Asset-Backed Securities Loan Facility, the expansion of the Money Market Mutual Fund Liquidity Facility, and the expansion of the Commercial Paper Funding Facility. Finally, to support small businesses, it also established the Main Street Business Lending Program.
It was a busy day.
March 23rd was the also the day the Federal Reserve made it clear that it intends to do whatever it takes with monetary policy to support the economy. The stock market certainly took them at their word. The S&P 500 rallied as much as 35% off its March 23rd low to its high on April 29, performing its high wire act with the knowledge that the Fed was providing a safety net below. That barrage of
monetary policy support gave the stock market a reason to look past the economic abyss towards better days ahead. Safety nets will give you that necessary sense of confidence.
The recent behavior of the bank stocks is telling everyone a much different story.
Something is Rotten in Banking Land
The banking industry, like many other industries, has enjoyed a bounce from the March lows. The SPDR S&P Bank (KBE) exchange traded fund is up approximately 18% since March 23rd.
That is rather good, but the S&P 500 is up approximately 30%. Additionally, the S&P 500 is down 12.0% year-to-date, whereas, the KBE ETF is down 44%. Additionally, in the graph below you will notice a marked decline of the banking industry performance relative to the market over the first two weeks of May.
SPDR S&P Bank ETF (KBE) vs S&P 500 (GSPC) – March 23, 2020 to May 15, 2020
Something is rotten in banking land, especially when we hear so much about how well-capitalized the banking industry is, how it trades at a discounted valuation, how it is in a good position to help the economy emerge from this unprecedented period of weakness, and how it plays such a prominent role in capital markets.
The banks are lenders; they are asset managers; they are deposit takers; and they are stewards of business formation and expansion. Given the better days ahead perspective that has steered the stock market since March 23rd, these stocks should be riding high, but the chart on the preceding page shows during May they are getting a bit sore in the saddle.
The Banks and Their Multitude of Worries
What is bugging the bank stocks? It is a multi-faceted problem.
Low Interest Rates – Recent declines in interest rates and the potential for rising credit losses have weakened the outlook for bank profitability, a key factor in banks’ ability to replenish their capital base.
Unemployment – With the continued rise in jobless claims, there is an expectation that they will have to take even larger provisions for credit losses, which will weigh on net income. When the banking standard bearer, JPMorgan Chase reported its Q1 results on April 14th, 22.03 million initial claims had been filed in the four-week period leading up to its report. Since then, another 14.5 million initial claims have been filed.
Dividends – The big banks are currently undergoing their annual stress tests and the results are due next month. Investors have worried that the sector will continue to be seized by low profitability due to low rates and loan losses. While many banks appear to be intent on paying their dividends, there are fears that dividends may be cut either from necessity or pressure from policy makers as a result of their current stress tests.
Negative Interest Rates – Falling interest rates are compressing net interest margins. Notwithstanding Fed Chair Powell’s recent indication that negative rates are not something the Fed is considering, investors can’t seem to dismiss the possibility of negative rates, which would be harmful for the banking industry and the economy, as they would be a disincentive for lending.
Tight Lending Standards – To some extent, banks are their own biggest impediment towards earnings growth. Because of the deterioration in economic conditions, banks are tightening their lending standards to help guard against making bad loans.
Sunk Costs of Excess Banking Real Estate Offices & Branches – Banks are sitting on a lot of real estate and office space they may no longer need with the success of work-from-home efforts and increased adoption of online solutions by customers. If a “return to normal” does not happen, they will be stuck with the added cost of these facilities.
The Bottom Line
Few companies are as important to our economic turnaround as the banks. If they are not providing as much capital through credit expansion, economic activity will be restricted.
Since March 23rd, the stock market has acted as if it expects the U.S. economy to return to normal as states reopen their economies. The bank stocks, however, look as if they pulled up lame after coming out of the March 23rd starting blocks. That is a problem, as it suggests the stock market has made a false start.
The stock market is enthused by the premise that things can only get better, because of the policy support and because of how bad things have gotten. There is some truth to the premise, yet the bank stocks are behaving as if things on the credit side are only destined to get worse given the rise in unemployment, the slow receipt of stimulus funds, and the deterioration in local and state finances. There is truth in that premise as well.
A lot looks clear now looking back to March 23rd, but looking at the bank stocks, they are sending a signal that the economic future is less clear than the stock market has made it out to be.
If the bank stocks are right, the stock market is apt to continue its recent losses.
We look forward to catching up with each of you, and we will be reaching out to schedule a time to meet over the phone or by a Zoom video link. In the interim, if you would like to get something on the calendar, please send me a note with some dates and times.
Warm regards, John