U.S. 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, Federal Reserve (Fed) normalization and prospects for deregulation and payouts.
There’s more to U.S. bank stock performance than interest rates, we believe. Higher rates tend to help banks’ profitability, and correlate with better share price performance. But U.S. bank stocks (green line in the chart below) shot up in late June even as the expected change in the federal funds rate (blue line in the chart below) slumped. Why? An annual stress test had cleared the biggest U.S. banks, raising investor hopes for more stock buybacks and dividend payouts.
We see three areas of support for U.S. 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 GPS supports this view, signaling sustained above-trend growth and suggesting recent weakness in inflation will prove transitory. U.S. 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 U.S. 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 U.S. banks discounted by 24% compared to 5% for European banks. Eurozone banks wrestle with negative interest rates, making them less attractive than U.S. 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. Read more market insights in my Weekly Commentary.
Listen to Richard Turnill and Jeff Rosenberg talk about BlackRock’s midyear investment outlook on the inaugural episode of our podcast, The Bid.
The iShares Dow Jones US Financial ETF (IYF) was unchanged in premarket trading Tuesday. Year-to-date, IYF has gained 10.08%, versus a 12.39% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of BlackRock.