Looking Ahead To ‘The Poor Bank Redemption’

“The Poor Bank Redemption”, reads the title atop the latest edition of BofA’s popular weekly “Flow Show” series.

There’s a reason the bank’s Michael Hartnett is a crowd pleaser, and it’s not just down to the charts, although he’s got a way with the eye candy too.

The figure (below) says it all. Banks have underperformed tech by the most during any period over the past two decades save the dot-com bubble and the GFC.

“Bears will argue that big 2020 underperformance of banks [is] a signal of no economic hope and a sinister repeat of 1999 & 2008”, Hartnett writes.

To be sure, banks face a unique set of headwinds, so you can’t simply write this off as another feature of the same environment that’s propelled tech to outperform value, cyclicals, and, more generally, equities expressions tethered to the cycle.

Then again, every sector has its own unique story. Energy has a tale or two to tell in 2020, that’s for sure. So if you accept that as a given, banks’ underperformance can, in fact, be characterized as just another manifestation of the dynamics discussed in these pages each and every week, most recently on Friday morning in “Zeitgeist Unchanged“.

In a Friday note, Kevin Muir, formerly head of equity derivatives at RBC Dominion, and better known for his exploits as “The Macro Tourist”, wrote that while “it seems to make sense that the market cannot do well when bank stocks underperform [given that] banks are the cornerstone of the economy”, it’s worth recalling that banks “have been in a secular relative bear market”.

Kevin’s point: “If you looked too closely at [banks’] relative performance for signals when to get in and out of the stock market, you would spend the majority of the time out”.

And yet, as BofA’s Hartnett writes, “autumn bulls [will] require profits to surprise to the upside allowing the rally in risk assets to broaden into high yield, value stocks, small-caps, and so on”.

That’s another way of saying it’s probably not healthy to keep relying on a narrower and narrower collection of (mostly tech) names to support the broad market. Because then it’s not very “broad”, is it?

So, what’s it going to take to revive banks? Well, a vaccine for COVID-19 would help to the extent it would catalyze “big GDP & EPS upward revisions” in the second half, helping to “flip” the zeitgeist from growth to value, Hartnett says.

In addition, the coordination of fiscal and monetary policy witnessed over the past several months needs to start manifesting in a revival of animal spirits. Here’s Hartnett:

Fiscal: 2020 policy stimulus has been massive ($18.5tn of which $10.5tn in fiscal & $8.0tn in monetary = 21% global GDP) (Chart 5) and coordinated (1st time in years monetary & fiscal, like two wheels of a bicycle, moving quickly in same direction working together); banks the natural hedge for fiscal success (key barometer to watch = small business confidence surveys, e.g. NFIB) in stimulating animal spirits.

And what about the election? Shouldn’t a Democratic sweep (the likelihood of which seems to be increasing with each passing Twitter tirade) be a bad omen for banks? Maybe. But maybe not if big fiscal stimulus (e.g., infrastructure, student debt forgiveness, and health care spending) help revive growth and set the country on a path to a robust new expansion.

Hartnett also notes that surging deposits aren’t translating into lending, and bank shares’ relative performance is, more than ever, tethered to rates. If rates ever rise, he says “global banks will become the instant leadership”. He also notes that the introduction of yield-curve control stateside would probably engender a knee-jerk rally, but risk-taking is key to a longer-term revival. To wit, from Hartnett again:

Risk-taking: bank deposits up $2.2tn since end-Feb but bank loans up only $0.5tn vs cash/reserves up $1.3tn and UST+MBS holdings up $0.3tn (Chart 6); bank stocks tied-at-the-hip to interest rates (Chart 7); if and when Fed/ECB/BoJ can ever raise interest rates global banks will become the instant leadership; ironically introduction by Fed of Yield Curve Control in Sept may in typical contrarian fashion trigger a rally in banks; but the other irony is that sustained bank performance first requires risk-taking to boost economic growth & interest rate expectations in 2021 & 2022; until then bank stock bulls will focus on China (has led virus, market & macro recovery) & Europe (start of fiscal stimulus).

In the meantime, banks are staring down the worst quarter since the GFC. Remember, Q1 barely captured any of the pandemic, which means Q2 results will show just how bad the fallout was for America’s largest financial institutions.

Unemployment surged during the quarter to the highest levels in recent history, and corporate bankruptcies rose sharply, with acute pain in retail and energy.

Read more: Facing Bankruptcy During The Best Quarter For Stocks Since 1998

Trading could be a silver lining, and you have to imagine that record corporate debt issuance and equity underwriting will be bright spots considering all the capital raised over April, May, and June. Refis could also be a boon.

But loan loss builds were pervasive in Q1’s numbers and provisions are seen hampering results again in the second quarter.

Ultimately, it’s hard to escape the notion that over the longer-term, it all hinges on the recovery — or lack thereof. “Our outlook is cautiously optimistic as we expect the economy to continue to gain momentum into the end of the year”, RBC said in a recent industry note.

As far as the read-through for the market as a whole, Muir says a look at history shows bank performance “is not a terrific signal and if you hear a pundit using bank weakness as a reason for being bearish on the market, just be aware they have probably been bearish for the past three decades”.

Oh, and one more thing. Late last month, Cowen suggested Elizabeth Warren is the likely favorite for Treasury secretary in a Biden presidency.

“We believe Warren would be an especially powerful secretary with Biden likely delegating to her primary responsibility for financial and economic policy”, Jaret Seiberg wrote.

I’m not sure how that would go over with bank bulls, but somehow I imagine Warren won’t be as friendly as Steve Mnuchin.

---