The banking sector offers a litmus test for technology stocks and healthcare that exploded during the pandemic. Banks, as highly leveraged institutions exposed to all types of businesses and sectors, offer a more complete perspective on the state of the underlying US economy than the broader stock market.
While the S&P 500 has returned to a deficit of around 5% this year, the KBW banking index remains down by almost a third. It makes sense and could continue. Banks will be the first to bear the brunt of an economic contraction that could exceed 5% of GDP in 2020, with an unemployment rate rising by 20%. During the stock market recovery that followed the 2008 crisis, financial institutions lagged behind the recovery. They had to pay fines for fault and had to repair balance sheets.
The current poor performance of banks has less to do with the problems of their own manufacturing and more to do with market concerns about pending credit losses. Low margins may also persist as interest rates rebound around zero. Any euphoria in the major stock market indices belies the events on the ground. Optimism about the economy and the markets should be held in check until the banking outlook itself improves.
The flash point for banks is the quarterly dividend. The share buybacks, generally a majority of the capital returned by the banks, have already stopped. Many, including the Managing Director of the IMF, say that the top 30 global banks, which spent $ 250 billion last year on shareholder return, must also suspend dividends.
The current dividend yields of the six big American banks oscillate between 2.5 and 4.3%, with the exception of Wells Fargo in difficulty. Investors seem to believe that the pressures on the banks are manageable. Admittedly, the gap between the 2-year and 10-year Treasury widened to the highest level in two years, an upward sign of an economic recovery. But it is only when bank stocks start to fall that real optimism will be in order.
