Investors Appreciate U.S. Bank Stocks in 2021

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Bank stocks, stuck in the investment niche for years, are back in favor, gaining additional support after Senate run-off races last week that transferred control to the Democratic Party.

The sector endured a difficult 2020 as coronavirus lockouts threatened to trigger a wave of defaults, leading to a period of marked underperformance since long-term interest rates began to fall in 2018, compressing profit margins.

But U.S. banking indices have outperformed the market as a whole by more than 25 percentage points since Pfizer and BioNTech announced on November 9 that their Covid-19 vaccine has been shown to be highly effective.

“Banks are moving from the land of misfit toys, where they were in the summer, to becoming an area of ​​interest for investors,” said Charles Peabody of Portales Partners, a banking research firm. “People pick up the phone when we call.”

Investors are now looking for stocks that could benefit from the vaccine rebound, while the Democratic Party’s prospect of controlling the White House and both houses of Congress has also fueled inflation expectations, triggering a increase long-term interest rates which bode well for bank profits.

After the release of Georgia’s earnings on Wednesday, shares of U.S. banks rose nearly 7%, their biggest daily gain since November.

The coronavirus crisis has made a string of poor performance much worse. The KBW Bank Index lost a quarter of its value from late 2018 to late 2020, underperforming the S&P 500 by nearly 50 percentage points. The valuation of the index, as measured by the price / earnings ratio, is now about half that of the market at large, says Autonomous Research. Historically, the banks’ discount has averaged 25 percent.

“The banks’ underperformance relative to the whole market in 2020 was really extreme – we had to go back to 2000 to find something similar, and when that reversed, banks outperformed for eight years.” said Ben Mackovac, portfolio manager of Strategic Value Bank. Partners fund, which invests in community banks.

The change in sentiment is most noticeable in the attitude towards Wells Fargo, which has yet to recover from its 2016 fake accounts scandal. Working under an asset cap imposed by regulators, the bank has lost more of half its value at the start of 2020. Since November, however, it has received five upgrades from Wall Street analysts, and shares have risen nearly 40 percent.

The gatherings are also visible outside the United States. In Europe, an index that tracks bank stocks in the benchmark Stoxx 600 index climbed 30% in November, its best month since 2009. Gregory Perdon, co-chief investment officer at Arbuthnot Latham, said bullish trading banks was downright outstanding in Europe as long as 10-year US government bond yields remained at around 1 percent or more.

A seasoned investor in finance remains skeptical. Dave Ellison, the large and small cap financial fund portfolio manager at Hennessey Funds, said that while banks have enjoyed a relief recovery, very low rates and weak growth are here to stay.

“A cost of funds of 3% and a return of 6% on a mortgage?” Those days don’t come back, ”he said. “How do you develop customers? Not on the price – the cost of capital is already zero. Not in service – you can’t compete with Apple or Google. “Its portfolios are dominated by non-bank financial services companies, such as PayPal and Visa.

But optimists point to several factors. Some believe that shareholders should benefit from a Rush share buybacks from banks in the coming months – a step that the US Federal Reserve reopened to lenders at the end of 2020.

According to autonomous estimates, the excess capital of large US banks amounts, on average, to 18% of their market capitalization, suggesting that they could buy back a significant chunk of their own shares.

Small bank stocks, meanwhile, could benefit from consolidation. In recent years, investors have reacted coldly to bank mergers, hesitating in the face of the hefty bonuses paid for goals. However, more and more banks are doing low or no-premium peer-to-peer mergers, modeled on the 2019 $ 28 billion BB & T-SunTrust deal that created Truist.

In December, Huntington Bancshares agreed to buy TCF Financial for around $ 6 billion, a small premium, bringing total transaction volume in 2020 to $ 32 billion, in line with totals for the past few years, despite the virus.

The final catalyst is the rise in interest rates and the steepening of the yield curve – a wider spread between short and long-term rates. A steeper curve means higher profits because it increases the difference between the cost of financing banks and what they earn by lending. Both the release of pent-up economic demand as the pandemic abates, and a supportive monetary policy, should in theory lead to a steeper curve.

David Konrad, banking analyst at brokerage DA Davidson, said that with the economy emerging from the Covid-19 crisis, “it’s hard to imagine that in the second half of next year, we won’t have no steepening curve ”.

Until recently, analysts and investors say, bank stocks have been viewed as a business rather than a long-term game, except among the small fraternity of investors specializing in the financial sector. For the group to take another step forward, they say, generalist investors must join.

For much of the past year, Konrad said, the banking space has been “a knife battle between hedge funds battling for positioning.” But a recent rally in US government bond yields has started to interest generalists, he added.

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