US bank stocks have suffered a brutal start to 2016. Out of the 90 stocks on the S&P financials index, just eight were in positive territory for the year at mid-morning on Tuesday.
Two of the biggest losers, Bank of America and Morgan Stanley, are down 27 per cent and 28 per cent respectively. Citigroup, also down 27 per cent, is now trading at just 6.5 times earnings, not far off its post-crisis trough of 5.9 times, reached during the depths of the European debt crisis five years ago.
What’s going on?
• Collapsing expectations of US interest rate rises
Analysts offer a lot of different reasons for the big sell-off, but on this they agree. “Lift-off” in December was supposed to usher in an era of higher interest rates — which are always good news for the banks. In previous rate-raising cycles, assets have always re-priced faster than liabilities, earning banks a bigger spread between the yields on their loans and the cost of their funds.
But worsening data since then from big economies, notably China, has investors worried that the world economy is a lot sicker than they had assumed. Expectations of another three rate rises from the Fed this year have collapsed in a matter of weeks. Talk of a rate cut, or even a move to negative rates, is entering the picture.
Meanwhile, the muted reaction to Japan’s latest burst of monetary stimulus has fuelled concerns over the power of central banks to defibrillate the world economy.
“The impact of [quantitative easing] seems to be becoming less meaningful,” says Brian Kleinhanzl, banks analyst at Keefe, Bruyette & Woods in New York. “Investors are worried about what central banks have left.”
• Worsening credit quality
In itself, a lower oil price will not do much direct damage to the big banks’ balance sheets, say analysts. Total energy exposures amount to less than 3 per cent of gross loans at the big banks, which have mostly investment-grade assets, and which have already pumped up reserves. Perhaps more worrying are the second-round effects: if weakness in oil-dependent communities begins to spill into commercial real estate loan books, say, or if consumers find they cannot afford repayments on loans for their new gas-guzzling cars.
In an environment of precious little growth — the big six US banks produced exactly the same amount of revenue last year as they did in 2014 — rising credit costs are likely to lead to lower profits.
• Deutsche Bank
Every sell-off needs a point of focus and in recent days it has been Deutsche Bank. The contortions of the Frankfurt-based lender weighed on the entire banking sector on Monday, as it fought to dispel fears that it could not pay a coupon on a bond.
“I think maybe counterparty risk is emerging,” says Shannon Stemm, an analyst at Edward Jones in St Louis. “At the root, are some of these [European] banks as well capitalised as the US banks? Probably not. Can they continue to build capital in an environment where there is not a lot of revenue growth, and a lot of expenses have already been taken out of the business?”
• Banks are banks
These are confidence stocks. When markets are doing well, banks tend to do well, as companies feel better about doing deals and raising money, investors put on a lot of trades, and asset management arms benefit from big inflows.
But when confidence disappears, banks tend to bear the brunt of the sell-off. Matt O’Connor, analyst at Deutsche Bank, notes that in 15 corrections going back to 1983, the US banks sector has been hit roughly twice as hard as the rest of the market — regional banks about 1.8 times worse, and capital markets-focused banks about 2.3 times worse.
“At the end of the day when markets get scared, banks go down more, that is just what happens,” he says. “There is not any kind of imaginary line where you can say, ‘OK this has gone down enough,’ and it’s now a recovery play or a turnround play. They just go down more, until they are done going down or markets feel better about macro conditions.”
• Bank stocks were not cheap before the slide
At the peak last July, the S&P 500 was trading about 20 per cent above historical levels, and bank stocks were up to 25 per cent higher than their historical averages, based on multiples of estimated earnings.*
But none of these reasons is providing much comfort to investors at the moment. At Edward Jones, Ms Stemm is recommending clients ride out the turmoil by switching big global universal banks for steadier, US-focused lenders such as Wells Fargo and US Bancorp.
“If there are global macro concerns, if recession concerns really are on the table, investors would rather get out than wait to see what happens,” she says.
* This story has been amended to clarify the gains of bank stocks