Stock of the week: the US banking sector
There are three key reasons why we are shining a spotlight on the US banking sector this week. Firstly, the outcome of the Federal Reserve’s stress tests for US banks was positive, it found that US lenders could lose up to $500bn in a major global downturn and still comfortably meet capital requirements. This news should boost confidence in US lenders and help to fend off attacks from challenger banks and digital start-ups. Secondly, this news means that restrictions on dividends and share buy backs can now be lifted. Lastly, we would note that US banks have benefitted from the hawkish Fed meeting earlier this month as short-end Treasury yields have started to rally. Over time, and if the US economic recovery continues to gain traction as many economists expect, we think that Treasury yields at the longer end of the curve will also rise, which is more good news for lenders in the long term.
Stress test glory set to drive US banking sector to new high
These are potent reasons why US banks should be in focus this week. We are expecting a wave of announcements from them in the coming days that will shed light on 1, the size of potential dividends, and 2, the scale of buybacks.
While we tend not to be fans of share buybacks as a means to drive stock prices higher – we tend to think that it suggests a lack of innovation at the executive level that can’t decide what to do with excess capital - this is an unusual circumstance. Banks were barred from giving investors dividends and entering into share buybacks due to the pandemic, so now that the ban has been lifted and banks are well capitalised after a bumper year for trading revenue, this news is a welcome sweetener for investors’ and it could keep US banks’ share prices buoyant in the coming days.
Where stock prices could go next
The S&P 500 banking sector rose 1% on Friday, bucking the general malaise across markets. Some analysts are expecting the largest US banks to return more than 100% of earnings to shareholders over the next year, which may amount to more than $200bn of capital. With announcements expected from some US banks as early as the start of this week, then we think that more investors will want a slice of this $200bn pie, which should drive the US banking sector higher in the coming days.
Banks compete to give back the most
If this sounds interesting, then the question now is which banks could see their share price perform the best in the coming weeks? At the end of last week, it was Capital One and Morgan Stanley that were the best performers in the US sector, up nearly 2% and 1.5% respectively. MS is expected to be one of the first banks, along with Goldman Sachs, to announce their capital giveaway plans, which may be the reason why it was a top performer late last week. Added to this, MS and GS were the banks that had the biggest hypothetical hit to their capital ratios during the Fed stress tests, with losses of 4.7% and 5.9% respectively, compared with an average of 2.4% for all major US banks.
In contrast, Capital One was the best performer in the stress test. This does not necessarily mean that Capital One will be the most generous US bank when it comes to capital giveaways, however, along with Morgan Stanley it is a bank that we will be watching closely this week. We would also suggest that you look at the US banking sector as a whole in the coming days, with the S&P banking sector on course to return to the 13-year highs reached in May.
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