So far this year, equities are down about 10%. Shares of financial firms have led the way, down about 15%. And longer term, bank stocks still haven’t recovered from their losses during the financial crisis. What’s wrong with them?
You could throw up your hands and attribute it to random price action, but that doesn’t make sense. Even though they’re hard to predict, there’s still some semblance of rationality to stock prices. When oil prices plunged, the energy sector fell at the same time. When that same drop in oil prices put more money into consumers’ pockets, consumer stocks rallied. So what’s the market telling us about the financial sector?
Some worry about the strong dollar and a weakening corporate profit picture, but that affects mostly exporters, who fund themselves in the capital markets, not via the banks. Others point to the increased regulatory burden caused by Dodd Frank and other post-crisis regulations, but those have been with us for a while. My bet is that global deflationary fears are infecting the financial sector. Deflation is like kryptonite for banks. Even a whiff weakens them. And it makes sense: banks are levered institutions. When the assets that secure their loans go down in price, those assets are more risky. A higher risk-premium is going to depress the value of bank shares.
Source: Financial Times
That’s why both stock and bond prices have fallen lately for banks around the world. The global economy isn’t necessarily headed for a recession, but it’s a risky place. Bankers could do everything right—control their credit risk, make sure they’re operationally tight, know their customers—and still hear politicians and regulators calling for Congress to break them up. Too big to fail is too big, they say. And banks are bigger now than they were in 2007, before the crisis.
That’s what’s weighing on banks. Just remember: banks are leveraged. They magnify the downside of things, but when the world doesn’t end, they have a way of roaring back.
Douglas R. Tengdin, CFA
Chief Investment Officer