Will the Dollar Recovery Launch a Bank Rally? 10 comments
-
Font Size:
-
Print
- TweetThis
Quite possibly. I warned back in April that there would be a second leg to the historic bank crisis which would undermine the bear market rally (see Banks: End of the Beginning...) and exposure should be minimised. Well, we're now below the March lows for the sector in the US and Europe, and self-serving rumours of a failed fundraising at HBOS and recourse to Fed funding for Lehman will potentially mark an important sector bottom. There is undoubtedly more bad news to come from US regional banks, credit card and car loan receivables, and indeed investment banks unable to evolve from a broken business model. The economic downturn will drive a further round of charges to weakened balance sheets, and compromise capital ratios.
Despite all this, for the leading retail banks, it's pretty much in the price and an historic buying opportunity is, I suspect, at hand. I've been a dollar bull (and gold bear) since March, and it's been a profitable call. After basing steadily for two months, this week we've seen the biggest fall in the Euro/Dollar in 2 years, despite the Trichet rate comments last week. What has been on the other side of the short financials trade? Resource stocks (energy now over 15% of S&P); if I'm right in thinking the bull market in commodities and associated resource stocks will be buried by a slump in emerging market growth and a rising dollar (still waiting for that oil crash, but be patient), we are going to see some brutal sector rotation in equity markets. Miners are already down 15-20% from their peak on falling industrial and precious metal prices, although energy plays have yet to correct.
The alternatives for big money switching are pharmaceuticals and financials (US tech is a loser on the strong dollar view, and Nasdaq looks up with events). The benighted Pharma sector has long run out of R&D road but managed decline is a good investment at the right in price, and the sector looks historically cheap on a DCF basis after an interminable bear market.
However, leading global banks like HSBC (HBC), BoA (BAC) and Royal Bank of Scotland (RBS) are in a much stronger position to grow earnings and dividends sustainably in coming years despite current uncertainties.
For a start the scale of the sector collapse is almost unprecedented; US financials are now down 41% since February 2007, and are lower than they were at the start of the decade. Just twice in the last 50 years have they fallen more, in 1987 post Crash by 45% and again in 1989 by a similar amount. Only the Pharma sector has been a worse performer over the last few years, and whatever their problems at least banks don't have the FDA to contend with. Crucially, the risk of an unquantifiable systemic banking crisis receded with the decisive Fed intervention post Bear Stearns and fundamentals do now matter.
Secondly, yield curves are now sloping nicely upward, particularly in the US, which will be a boon to underlying profitability going forward; banks are a good inflation play. From reckless complacency in risk management, we have now swung to extreme caution across the credit markets. Smart investors like bond giant PIMCO are now investing heavily in mortgage bonds at huge discounts. To quote the Bank of England 'estimates implied by prices in some credit markets are likely to overstate significantly the losses that will ultimately be felt by the financial system and the economy as a whole, as they appear to include unusually large discounts for liquidity and uncertainty'.
Thirdly, retail banks have one of the strongest franchise values of any business because of sheer customer inertia, and many of the big retail names like Wells Fargo (WFC), RBS and HSBC are long term bargains just on their core 'boring' deposit taking business. The housing markets in the US and UK are not as dire as the bears claim, the UK because of a lack of supply discussed in a previous post, the US because the inventory overhang is being steadily reduced amid a slump in supply and strong demographics. A turning point in perceptions is likely within months.
Many major banks are now yielding close to double digits, and trading well below book value. Bank of America for instance, which has remained profitable throughout the credit crunch, is yielding 8.3% and trading well below (admittedly uncertain) book value. An investor buying those leading global banks at a discount to book with decent dividend cover and Tier 1 ratios (or preferably good old fashioned tangible asset to equity ratio) could reasonably expect 25 to 50% upside on a 12 month view. The days of bank assets in aggregate growing in excess of GDP are well and truly over, but on these ratings that's discounted.
We have seen little M&A in the sector apart from distressed deals like BoA/Countrywide (CFC), but we are likely to see long mooted strategic bids soon, particularly Europe into the UK (which would be hugely bullish for the UK housing sector). Abbey/Santander is now a top 3 UK mortgage lender precisely because as a Eurozone domiciled bank it has access to the ECB funding window at 4% and can make huge profits lending competitively in the dysfunctional UK market.
I'm an investment contrarian by nature, but never recklessly so; the balance of risks is now to the upside, although another 5-10% downside move is still possible. On balance, a strong technical rally in quality financials looks likely, and indeed the major names have the scope to be among the best large cap performers over the next couple of years from these levels. Watch commodity prices and resource sector rotation for a lead, but as the dollar has shown, the point of maximum pessimism is often a classic buying opportunity.
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Bill Gross
-
3
Philip Davis
-
4
Tyler Durden
-
5
TraderMark
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 10 comments:
This is an interesting observation:
"Abbey/Santander is now a top 3 UK mortgage lender precisely because as a Eurozone domiciled bank it has access to the ECB funding window at 4% and can make huge profits lending competitively in the dysfunctional UK market."
Thanks again.
CrossProfit
As for commodities, the present run-up may well be the result of banks attempting to backfill their subprime and credit default swap losses by speculation (using money from Fed credit lines!). A reversal of those gains in the short term depends upon action by the Commodity Futures Trading Commission action, but the CFTC seems quite willing to look the other way, even as Congress raises its eyebrows. It may well be that such speculation is all that is holding up the financial sector that you are predicting will revive. So, if I'm correct about this connection, then the very fall in commodity prices that your article predicts may result in the punishment of such speculating banks, and bring further pain to the financials that your articles predicts will rebound from funds shifting out of commodities and into the financial sector.
It such a volatile mess out there, and so much of what goes on is not public, that one has to make guesses as to what it really occurring, so there you have mine.
As you say, there is a falloff in demand at these rates, and so the upside of that market seems limited, while the downside is substantial, given that it is a bubble.
Thanks