European and US Bank Stocks Face Their Toughest Challenge Yet
Just recently it was announced that Deutsche Bank (DE:DBKGn) of Frankfurt has suffered losses of up to 40% in 2016. This news is hardly surprising given the pervasive weakness that the global economy is undergoing. The once indomitable Deutsche Bank is but one of many banking powerhouses around the world that is on skid row. The volatility in the banking sector has been so dramatic that Deutsche Bank shed 9.5% on Monday, 8 February, 5% on Tuesday, 9 February and bounced back 11% on Wednesday, 10 February after an emergency bond buyback plan was announced. Such is the uncertainty in the banking sector that financial stocks are not being considered as safe haven investments at this juncture. Deutsche Bank was last trading at $15.38 on the New York Stock Exchange, at a -1.03% change for the day.
US Banks Reeling
But the bigger problem is with US bank stocks. The leading US banks include the likes of: US Bank, Wells Fargo (N:WFC), JPMorgan Chase & Co (N:JPM), Goldman Sachs (N:GS), BNY Mellon, Bank of America (N:BAC), Citigroup Inc (N:C) and Morgan Stanley (N:MS). The year-to-date performance of these banks has been anything but exemplary. US Bank has shed 7.7%, Wells Fargo -14.6%, JP Morgan -14.9%, Goldman Sachs -17.7%, BNY Mellon -18.5%, Bank of America -27.5%, Citigroup -27.5% and Morgan Stanley -27.9%. This begs the question: Why are US banking stocks facing such negative sentiment when the US economy is effectively fundamentally sound? The issue is not so much the inability of banks to generate positive revenues – which they have been doing; it is investor sentiment about the global economy that is causing this reaction. The negative perceptions relating to China weakness, the commodity price rout - notably crude oil hitting multiyear lows, US dollar strength and interest rates are weighing heavily on US bank stocks.
Interest Rates Crush Bank Hopes
Interest rates are perhaps the biggest determinant of sentiment when it comes to the US banking sector. On 16 December 2015, the Federal Reserve Bank decided to implement the first rate hike in 9 years in the US. There was tremendous anticipation about the rate hike, and the implications that it would bring with it. When the Fed increased the rate by 25-basis points to 0.50%, there was an expectation that additional interest-rate hikes totaling well over 1% for 2016 would come into play. Banks like interest-rate hikes because they are able to generate increased revenues and profits from the clientele when rates rise. However the state of the global economy is such that it becomes exceptionally difficult for the Fed to justify raising interest rates under current conditions.
The Chinese economy has recorded its steepest GDP decline in over 25 years with a growth rate of under 7%, at 6.9% for 2015. Expectations for 2016 are none too rosy either, with the 180° pivot in China weighing heavily on economic performance. But it is the commodity price rout with oil prices trading well below $30 per barrel that is causing deflationary concerns in the global economy. If the Fed factors in the bigger picture, it is highly unlikely that any significant rate hikes will be implemented in 2016 under current conditions. This is driving negative sentiment for US banks which were counting on increased interest rates for 2016 profitability. Several high level investors have however cautioned that the credit contraction taking place in the US and elsewhere and overvalued stocks especially in China could be pointing in the direction of a recession for 2016. Whether this comes to pass or not is uncertain at this point.
Is there value in US bank stocks?
Some folks may be concerned that US banks have way too much exposure to energy companies and the losses that they are accruing as a result of weak oil prices. In fact, US banks have a maximum exposure of 3% to the losses being suffered by major energy companies. The vast majority of bank holdings lie with secure credit in the form of mortgages, long-term loans, credit cards, business investments and the like. Several weeks ago, Bank of America made $500 million available for emergency purposes for energy companies as a result of weak oil prices – so clearly this is not an issue for banks. The bigger issue is the impact of the shuttering of shale oil industries across the country and the impact it will have on the communities that depend on it. This will directly affect mortgage repayments, car repayments and credit facilities which have already significantly tightened. In the S&P 500 index, there are 90 financial stocks and just 8 of them have ended in the black this year. The rest have performed well below expectations after being overvalued by the midpoint of 2015. Nonetheless, at current prices, bank stocks are making a case for investment. Morgan Stanley is trading at $22.94, Bank of America is trading at $12.20 Goldman Sachs is trading at $148.25, and Citigroup Inc (N:C) is trading at $37.52. While the prospects over the short to medium term are bearish, now is definitely a good time to consider bank stocks as a viable investment option over the long-term.