Check out the stats in a Financial Times story from earlier this week:
* Between Jan. 4 and Feb. 15, the S&P 500 lost around 7.5%. But the bank-stock benchmark dropped 16.1%.
* In Europe, the FTSE Eurofirst broad-stock index dropped 9.5%. But the benchmark index for European bank stocks plunged 19.5%.
* The story goes on to note that the S&P 500 remains about 23% above where it traded in July 2007, the peak of the last bull market and the top of the last major credit cycle. But the banking sector is still trading for 51% less than it was back then.
* In Europe, the benchmark stock average is still 21% below where it traded in mid-2007. But the banking sector is going for a whopping 71% less than it did back then.
In other words, bank stocks rebounded less than the broader market after the LAST credit-cycle crisis. And they’re finding themselves in the bulls-eye of THIS credit-cycle crisis, too.
|Bank stocks are finding themselves in the bull’s-eye of the current credit-cycle crisis.|
Why? There are several reasons …
First, banks and other financial firms are among the most-levered to the performance of credit markets. That’s because credit is their business. They make loans, invest in and underwrite bonds, advise on corporate takeovers and stock sales, and otherwise make or lose money depending on the health of the credit markets.
Second, banks are highly leveraged, or reliant on borrowed money to enhance returns. As the FT story notes, “If one ignores the vanishing trick of risk-weighting, the true leverage of many large banks remains at more than 20 to one.”
The problem is that leverage cuts both ways. You can make more money than the average, lightly leveraged company in bull cycles, but you stand to lose much more in bear cycles.
Third, banks have been doing all kinds of foolish things lately, egged on by central bankers and their NIRP/ZIRP/QE programs worldwide. Between 2010 and 2015, we saw a huge boom in subprime auto lending, a huge boom in commercial-real-estate lending, a huge boom in junk-bond underwriting, a huge boom in leveraged corporate takeovers, and more.
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Now with those bubbles popping, it’s going to drive up loan defaults and drive down investment and underwriting revenue. Declines in inflated asset values will put even more pressure on financial stocks.
Fourth, banks are suffering from the ill effects of post-crisis regulations. They’re facing restrictions on several activities. They’re burdened by huge compliance costs. And they’re getting buried under multibillion-dollar lawsuits around the world.
Finally, in an effort to avoid future government bailouts, regulators instituted so-called “bail-in” policies after the crisis. Those measures stick more bondholders and equity holders with the bill for financial failures.
That’s morally defensible and better than hitting up taxpayers. But it has the perverse side effect of helping intensify electronic “runs on the bank” in bank shares and bonds during times of crisis.
Bottom line: During the housing and mortgage crisis of 2007-2009, banks and other financial firms got crushed. Now, that process is playing out again in 2016, with foreign banks getting hit particularly hard.
That provides me with more evidence that another great credit-cycle turn is at hand, and that the consequences will be both widespread and severe. So make sure you keep that in mind when making choices about which sectors and stocks to invest in or which to avoid.
Until next time,
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