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Time to buy US banks?

25-Sep-2017
By BlackRock Investment Institute, Richard Turnill

Key points

  1. We like US banks because of sustained economic growth, normalizing monetary policy and prospects for deregulation and increased payouts.
  2. The Federal Reserve announced plans to start winding down its balance sheet in October, and kept a December rate increase on the table.
  3. A key inflation gauge this week could confirm our view that US inflation is set to rise toward the Fed’s target of 2%.

Time to buy US banks

US banks have lagged the broader market and European peers year-to-date. We believe this trend has turned. We see the group up in the medium term on sustained economic growth, Fed normalization and prospects for deregulation and payouts.

Chart of the week
Rate expectations and US bank stock performance, 2015-2017

Chart of the week

Sources: BlackRock Investment Institute, with data from Thomson Reuters and Bloomberg, September 2017. Notes: Interest rate expectations are represented by the expected change in the federal funds rate in 12 months, calculated using the overnight index swap (OIS) curve based on the difference between the spot rate and the one-year forward, one-week maturity rate. The relative performance of US banks is calculated by dividing the performance of the S&P Banks Index by that of the S&P 500 Index, rebased to 100 at the start of 2015. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

There’s more to US bank stock performance than interest rates, we believe. Higher rates tend to help banks’ profitability, and correlate with better share price performance. But US bank stocks (green line) shot up in late June even as the expected change in the federal funds rate (blue line) slumped, as shown in the chart. Why? An annual stress test had cleared the biggest US banks, raising investor hopes for more stock buybacks and dividend payouts.

Of rates, regulation and payouts

We see three areas of support for US banks: a gradually steepening yield curve, possible deregulation and increased payouts. The Fed’s efforts to shrink its balance sheet and normalize rates is likely to cause the yield curve to steepen. We think investors are still underestimating the potential for rates to move up and the yield curve to steepen, both critical to banks’ profitability. Our BlackRock Inflation GPS supports this view, signaling sustained above-trend growth and suggesting recent weakness in inflation will prove transitory. US regional banks stand out as potential beneficiaries, as they tend to have a greater share of their business in traditional banking services such as loans and deposits than the larger competitors. Another potential help: a looser regulatory grip from Washington. The key for deregulation to move forward will be the confirmation of the Fed’s top banking regulator and his immediate guidance on priorities. Filling the vacancies in related government agencies will also be instrumental for deregulation to gain traction. 

Analysts expect US bank earnings to grow 12.8% in 2018. We see scope for this number to improve. Global banks as a group are trading at a bigger discount to the broader market than their 10-year average, with US banks discounted by 24% compared to 5% for European banks. Eurozone banks wrestle with negative interest rates, making them less attractive than US peers. We currently have little appetite for Japanese banks despite their appealing valuations given easy Bank of Japan policy.

To boot, banks largely passed a key Fed hurdle this June for returning capital to shareholders, setting the stage for buybacks and dividends. Our bottom line: We see opportunities in U.S. bank stocks in the medium term.

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  • Global stocks hit new highs, government bond yields rose and the dollar rallied. Hurricane Irma caused considerable devastation but the damage was less severe than many had feared.
  • US core inflation picked up in August. Hawkish comments from the Bank of England reflect six-year-high inflation and the lowest unemployment rate since 1975. The British pound rose to a one-year high against the US dollar.
  • Base metal prices fell to multi-week lows, pressured by a stronger dollar. Oil rose on the improved demand outlook from the International Energy Agency and the Organization of the Petroleum Exporting Countries (OPEC). Lower OPEC output in August also helped.

 


Date: Event
Sept. 19-20 Federal Open Market Committee (FOMC) meeting
Sept. 21 Eurozone flash consumer confidence indicator; Bank of Japan monetary policy meeting
Sept. 22 U.S., eurozone, Germany and France composite purchasing managers’ index (PMI)
Sept. 24 German federal election

The Fed is expected to announce its plan to start gradually winding down its balance sheet in October. Investors do not anticipate a rate increase at this meeting, but see the odds of a December rate increase rise to roughly 50%, from 37% at the end of August.

Richard Turnill
Managing Director, ist Global Chief Investment Strategist von BlackRock
Richard Turnill ist Global Chief Investment Strategist von BlackRock. Davor war er Chief Investment Strategist von BlackRocks Fixed Income und active Equities ...

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Sources: Bloomberg unless otherwise specified.

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