Banks' Stress Tests To Reveal How Fragile Markets Are

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European Banks' Stress Test Show the Weaknesses of the Banking Sector.

BoE to Convince Investors That Economy is Strong.

Volatility Still in Low Levels.

Another Positive Week for Precious Metals.

Markets were quiet last week with most events being expected by the markets. German economic figures were above expectations (business climate 108.3 (est. 107.5, consumer confidence 10.0 (9.9), unemployment change -7K (est. -3K), Prices +0.4% (est.+0.3%), retail sales up 2.7% (est. 1.2%) YoY. The better than expected economic figures pushed the DAX higher 1.9% this week.

On the other side of the Atlantic Ocean, the Fed kept rates unchanged on Wednesday but indicated that an increase should be expected later this year. The Fed, as other central banks did earlier this month, stressed the risks arising from Brexit but it seems that as somebody commented in the G20 meeting last Sunday, the global economy is in a "good shape" and can be resilient. A Brexit can be absorbed by the markets and the economies which are prepared to take action if needed. Not surprisingly, the US market has closed just below previous week's level with Fed's monetary policy statement weighing on the stock market. FTSE closed slightly lower than last Friday. The GDP growth was higher than expected YoY +2.2% vs 2% expected while most EU figures were in line with projections.

World ETF Performance
Ticker Name Return since Brexit 1 Week 1 Month YTD
IWRD iShares Core MSCI World UCITS ETF 1.82% 0.91% 5.38% 4.29%
SPY SPDR S&P 500 ETF 2.99% -0.06% 5.06% 6.50%
DIA SPDR Dow Jones Industrial Average ETF 2.40% -0.74% 4.24% 5.83%
EWG iShares MSCI Germany ETF -1.50% 3.51% 8.18% -2.06%
EWQ iShares MSCI France ETF -3.04% 3.14% 6.78% -1.07%
EWU iShares MSCI United Kingdom ETF -5.74% 0.97% 4.21% -3.35%
CSX5 iShares Core EURO STOXX 50 UCITS ETF -1.66% 0.48% 5.57% -5.93%
EWJ iShares MSCI Japan ETF 1.94% 1.69% 3.97% -0.50%
AAXJ iShares MSCI All Country Asia ex Japan ETF 4.70% 0.70% 6.62% 7.92%
EEM iShares MSCI Emerging Markets ETF 4.16% 0.65% 6.42% 12.47%
MCHI iShares MSCI China ETF 3.31% -0.61% 5.39% -1.34%
Source: Bloomberg

Next week the focus will be on BoE which will announce the policy rate on Thursday and is expected to give a clearer picture of the ways it will support the economy in the after-Brexit era. On Monday the focus will be on UK, EU and US PMI with US unemployment and price indicators being announced during the week.

European Banks' Stress Test

The European Banking Authority's stress test results were announced on Friday. EBA decided not to give a fail to any bank but it is more than clear that most banks CET1 capital ratio has been deteriorated since the last stress test. Earlier in 2016 and mainly during the last few weeks, the markets have discounted the bad news for many banks (Deutsche Bank, RBS, Monte dei Paschi, etc).

The stress test adverse scenario is far mild as it assumes a real GDP growth of -1.2% in 2016, -1.3% in 2017 and 0.7% in 2018. During the financial crisis of 2008 the reduction in the growth rate was much higher than these assumptions and given the fragile economic environment in Europe as a result of the Brexit and the political crisis in Europe, the assumption look pretty much mild.

The 1 trillion of bad loans sitting on the European Banks' balance sheets show the fragility of the European banking sector which we think now contain more risk. We believe much more caution must be given to the probability of another crisis in Europe. Bad loans constitute a major problem for Banks in South Europe but the integration of the European Banking sector makes the "toxic cloud" easily transmittable to the rest of the Europe.

Ticker Name Return since Brexit 1 Week 1 Month YTD
JPM JPMorgan Chase & Co -0.1% -0.1% 4.5% -3.1%
C Citigroup Inc -1.5% -1.1% 4.0% -15.3%
BAC Bank of America Corp 3.2% 0.8% 9.9% -13.9%
GS Goldman Sachs Group Inc 4.0% -1.0% 9.1% -11.9%
MS Morgan Stanley 5.3% -0.7% 13.9% -9.7%
BNP BNP Paribas SA -7.0% 2.2% 12.3% -15.1%
8604 Nomura Holdings Inc 9.7% 9.0% 29.9% -30.9%
UCG Unicredit SpA -19.5% -4.1% 13.8% -57.3%
DB Deutsche Bank AG -24.7% -6.3% -4.6% -44.3%
UBSG UBS Group AG -12.8% 1.4% 5.1% -31.6%
RBS Royal Bank of Scotland Group PLC -23.2% 1.6% 6.8% -36.3%
GLE Societe Generale SA -15.7% 1.1% 9.5% -28.2%
CSGNz Credit Suisse Group AG -14.6% -1.8% 6.8% -48.8%
HSBA HSBC Holdings PLC 8.9% 0.3% 9.4% -7.7%
LLOY Lloyds Banking Group PLC -26.3% -2.5% -4.3% -26.7%
BARC Barclays PLC -17.3% 1.8% 12.0% -29.4%

The UK stock market above pre-referendum levels

FTSE has outperformed international indices since Brexit but investors must be cautious. FTSE has returned 6.1% since Brexit but where does this return come from? The stocks which contribute on the noticeable return are international companies, companies with exports and those which will benefit from an interest rate cut (i.e. REITs). However, FTSE return in dollar terms is not that great as sterling is 12% lower than dollar so far and the future for the British currency does not look that bright. International investors should probably take a closer look at foreign currency terms.

Volatility still fools investors

Volatility continues being at the bottom of the ocean. As I mentioned in the last article, the uncertainties surrounding the UK, EU and the world economy, do not seem to be priced in the volatility. Despite the fact that more and more negative news are announced, we see no upward movement in volatility which is not sensible. Another sign that makes us believe volatility in unreasonable levels in the return in the precious metals and fall in energy commodities which is a sign of market uncertainty. We expect that this will have to change soon. The Bank of England policy, its comments regarding the UK economy and the results of the stress tests are expected to influence volatility and eventually price this in.

Commodities Return
Ticker Name Return since Brexit 1 Week 1 Month YTD
GLD SPDR Gold Shares ETF 7.38% 2.08% 2.50% 27.12%
SLV iShares Silver Trust ETF 17.34% 3.64% 11.40% 46.70%
USO United States Oil Fund -18.53% -6.33% -17.22% -11.27%
UCO ULTRA BLOOMBERG CRUDE OIL ETF -34.45% -12.45% -32.17% -31.58%
GSC iShares S&P GSCI Commodity-Indexed Trust ETF -11.91% -2.72% -8.80% 1.69%
DBA PowerShares DB Agriculture Fund -6.83% -0.68% -7.21% -0.10%
UNG United States Natural Gas Fund 5.69% 4.52% 1.30% -1.38%
PPLT ETFS Physical Platinum Shares ETF 18.69% 5.93% 13.64% 28.30%
DBP PowerShares DB Precious Metals Fund 9.28% 2.60% 4.21% 31.22%
UGA United States Gasoline Fund -18.89% -3.25% -14.53% -22.80%
Source: Bloomberg
S&P500 Weekly Winners/Lossers
Ticker Name Weekly Return
SRCL Stericycle Inc -15.83 %
AKAM Akamai Technologies Inc -12.71 %
TGNA Tegna Inc -11.87 %
CI Cigna Corp -11.67 %
LVLT Level 3 Communications Inc -11.07 %
HIG Hartford Financial Services Group Inc -10.99 %
RHI Robert Half International Inc -10.83 %
WFM Whole Foods Market Inc -9.61 %
WDC Western Digital Corp -9.33 %
EMN Eastman Chemical Co -9.31 %
LLTC Linear Technology Corp 24.18 %
GRMN Garmin Ltd 17.98 %
STT State Street Corp 12.95 %
ILMN Illumina Inc 10.34 %
VAR Varian Medical Systems Inc 8.85 %
REGN Regeneron Pharmaceuticals Inc 8.63 %
JWN Nordstrom Inc 8.25 %
MAS Masco Corp 7.96 %
EW Edwards Lifesciences Corp 7.78 %
BHI Baker Hughes Inc 7.36 %
Source: Bloomberg

Read the UK outlook in the previous article and note that we change the Banks's outlook to Bearish for the reasons described above.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.