The banking sector offers a litmus test for the technology and healthcare stocks that have rocketed during the pandemic. Banks, as highly leveraged institutions exposed to every kind of business and sector, offer a more comprehensive perspective on the state of the underlying US economy than the broader stock market.
While the S&P 500 has clawed back to a deficit of just about 5 per cent this year, the KBW bank index remains down almost one-third. This makes sense and could continue. Banks will be the first to bear the brunt of an economic contraction that could exceed 5 per cent of GDP in 2020, with unemployment pushing 20 per cent. In the equity market rally that followed the 2008 crisis, financial institutions lagged behind the recovery. They suffered from paying fines for misconduct as well as needing to repair balance sheets.
Banks’ current poor performance has less to do with problems of their own making and more about market worries of pending loan losses. Also weak margins could persist while interest rates bounce around zero. Any euphoria in broad stock market indices belies the events on the ground. Optimism about the economy and markets should be reserved until bank prospects themselves improve.
The flashpoint for banks is quarterly dividends. Stock buybacks, typically a majority of the capital returned by banks, have already stopped. Many, including the managing director of the IMF, argue that the top 30 global banks, who last year spent $250bn on shareholder capital returns, must halt dividends as well.
Current dividend yields for the big six US banks hover between 2.5 and 4.3 per cent, with the exception of struggling Wells Fargo. Investors appear to believe the pressures on banks are manageable. True, the spread between the 2-year and 10-year Treasury has widened to the largest level in two years, a bullish sign for an economic recovery. But it is only when bank shares begin to snap back that true optimism will be warranted.