Banks suffered a sell-off globally in the aftermath of last week’s FOMC meeting. Surprising move as the Fed’s monetary policy starts to be more hawkish and this is normally considered good for banks. The explanation is to be found in the fact that investors have eased their positions on reflationary assets as inflation expectations have declined.
“In essence, while perceived aggressive decisions would theoretically be positive for bank earnings (via higher short-term rates), this advantage was more than offset by the negative impact on the earnings multiple (which tends to decline on a flattened returns) ”, remarks Mark Conrad, Algebris portfolio manager. However, the expert clarifies a couple of points. First, while the Fed’s latest tapering move caused the curve to flatten, the assumption that a flatter curve means lower-valued bank stocks doesn’t necessarily hold up. The US 2/30 curve tumbled from 300 to 50bps as the Fed reduced (and subsequently increased) stimulus from 2014 to 2018 and the US bank index rose from 70 to 110. Second, while we believe that it is too early to conclude that the reflexive rally is over, there is a lot more to like for banking equities than sensitivity to a steeper curve. Significant returns on capital, an accelerating cycle of earnings growth, a nascent cycle of mergers and acquisitions and historically low valuations are all key factors providing a strong fundamental background for European banking equities over the next couple of years.