By John Carney
The dual prospects of a Donald Trump presidency and further
interest-rate increases lifted banks' shares in the closing weeks
of 2016. This year will reveal whether a new economic order will
actually emerge, and boost banks' businesses with it.
The outcome is crucial for both broader markets and the nation's
outlook for growth. Financial stocks are a big part of the S&P
500, and banks' ability and willingness to lend could prove
critical to the business boom the Trump administration aims to
generate.
So far, markets are upbeat on the possibilities, betting banks
will benefit from higher rates, that other businesses can tolerate
them and that less regulation and lower taxes will help the economy
overall.
The S&P 500, which plummeted at the start of 2016, closed
the year up 9.5%. Meanwhile, the Dow Jones Industrial Average rose
13%.
The jubilation is particularly apparent among financial stocks:
Among S&P 500 sectors, financials were the second-best
performer in 2016, up 20.1%.
The KBW Bank Index has risen about 22% since Election Day,
hitting its highest level since 2009. That is a dramatic reversal
for an index of large national and regional banks that had spent
the first 10 months of the year below its year-prior levels and at
some points hit multiyear lows.
The gains reflect investor expectations for the broader economy
since the firms' big revenue generators -- lending, trading and
capital-markets activity -- are closely correlated to economic
growth, interest rates and the steepness of the yield curve, or the
difference between long- and short-term rates. The bigger the
difference, the better it is for banks because they borrow short
term and lend long term. Expectations for higher rates and a
steeper yield curve have been rising since the election, while the
Federal Reserve has echoed that by signaling three more
interest-rate increases could be in store in 2017.
Another plus for banks: the idea that the Trump administration
will usher a less onerous regulatory environment. Less regulation
could allow banks to boost profits and capital returns to
shareholders.
If there is a problem for bank-stock investors, it is that
shares are priced at levels that suggest the future is already
here. "While we're constructive on banks, the rapid rise has us
nervous," said Terry Gardner, a portfolio strategist at
investment-management firm C.J. Lawrence.
And soaring share prices have pushed up some valuation measures
sharply, in many cases beyond historical averages.
Shares of five of the six largest U.S. banks -- J.P. Morgan
Chase & Co., Bank of America Corp., Wells Fargo & Co.,
Goldman Sachs Group Inc. and Morgan Stanley -- are trading at more
than 13 times forward earnings estimates, compared with averages of
between 10 and 12 times over the past 15 years, according to
FactSet. Citigroup Inc. is the only laggard, trading at just shy of
12 times forward earnings, although that figure is still up sharply
from less than 10 times before the election.
But valuations may appear lofty because many analysts haven't
yet formally adjusted earnings forecasts in light of the election.
If those climb, valuations will look more reasonable.
For example, a combination of accelerated share repurchases -- a
possibility if the Trump administration appoints less-stringent
banking regulators -- steeper yield curves, accelerated loan growth
and more-robust trading and investment-banking revenue could push
earnings per share for big banks up by 18% over analysts'
pre-election estimates, according to Credit Suisse bank
analysts.
And potential changes to corporate-tax rates could boost bank
earnings further, even if some may take hits to tax assets on their
books generated by prior losses. Sanford C. Bernstein bank analyst
John McDonald recently estimated that cutting the corporate tax
rate to 20% from the current 35% would raise Wells Fargo's earnings
per share 18% above the firm's 2018 forecast. J.P. Morgan's
earnings would rise by 13%, Bank of America's by 12% and
Citigroup's by 10%.
Just how much benefit further regulatory changes could bring is
less clear, although investors are betting they will do more good
than harm.
As a candidate, Mr. Trump promised to roll back the Dodd-Frank
Act, the postcrisis law that dramatically increased regulatory
oversight of the U.S. financial system as a whole and banks in
particular. In response, lenders have had to increase the amount
and quality of their capital and available liquidity, revamp their
trading operations, and extend the duration and stability of the
debt they use to fund themselves.
Many observers have suggested that these changes are responsible
in part for the low returns on equity banks have reported in recent
years. Those low returns have depressed bank valuations.
But dramatic changes to the regulatory environment -- including
a possible repeal of Dodd-Frank itself -- wouldn't immediately
boost bank profitability. The changes banks have made to their
operations and funding can't be instantly reversed, even if that
were what banks wanted to do. And there are indications banks
aren't looking for a complete reversal of regulatory direction.
"We don't need to tear up the rule book," said Francesca
Carlesi, head of regulatory affairs at Deutsche Bank. "We need time
to digest the rules we have."
Academic studies also suggest it can take banks several years to
adjust to major shifts in regulation. In the short term, that could
actually be a drain on earnings as banks may have to spend more to
adjust compliance systems around new rules.
While banks have been the come-from-behind underdog stocks of
2016, little of their gains are due to anything the firms
themselves have done. In 2017, their fates will also be largely
decided by forces outside their control.
Write to John Carney at john.carney@wsj.com
(END) Dow Jones Newswires
January 02, 2017 09:25 ET (14:25 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
Bank of America (NYSE:BAC)
Historical Stock Chart
From Aug 2024 to Sep 2024
Bank of America (NYSE:BAC)
Historical Stock Chart
From Sep 2023 to Sep 2024