The United States' biggest banks have had a tough year, what with a regulatory crackdown, growing worries about a double-dip recession and new fears of exposure to European contagion. The country's bank stocks seem to be pricing in all that grim news – plus war, famine and pestilence.
After falling more than 20 per cent through the first nine months of the year, some large U.S. banks are closing in on the low valuations of March, 2009. "Investors seem to have taken the approach of sell first, ask questions later," says RBC Dominion Securities Inc. analyst Gerard Cassidy.
Indeed, regular readers of Vox may recall that this column has recommended several U.S. banks - four since June, to be exact. All four have declined, with two - PNC Financial and Bank of America — down by double-digit percentages.
Time to withdraw those "buy" calls? Time to say the only way to make money in financial stocks is to invest in Canada's more robust banking sector?
No. It's time to say that strong-stomached investors should buy in to the sector now, so long as you have the patience to hold on for a year or more.
The pricing of bank stocks has come "unhinged from the fundamentals," says analyst Robert Patten of Morgan Keegan, with many investors expecting "a potential 'Lehman [Brothers]type' event in Europe. Mr. Patten, correctly, says "this is not 2008." While Europe's current problems are scary, few major U.S. banks have substantive exposure to the continent.
Alas, the current earnings season for the big U.S. banks, which kicks off today with JPMorgan Chase & Co. , is likely to contain little news that will turn around perceptions immediately. While most banks will show improving asset quality and earnings, the financial companies with large capital-markets operations will show diminished results. Analysts have been scaling back earnings estimates out of concern over the current macro environment.
The gloomy headlines will obscure a growing swell of good news for the majority of banks. Barclays Capital analyst Jason Goldberg believes most financial institutions will show increased earnings, loan balances and tangible book values. The bulk will also show record capital ratios and deposit levels, as well as improved asset quality, as measured by charge-offs, non-performing assets and the release of reserves for bad loans. "While the third quarter will likely be 'as advertised,' we think [the positive aspects are]underappreciated," he says.
Just as earnings will not drive a quick rebound, neither will the U.S. economy, as there seems little chance of clear signs of a turnaround. "We feel that we are 'Waiting for Godot' – i.e. our forward estimates reflect a more normal environment that never seems to come," says analyst James Mitchell of Buckingham Research Group.
The one thing in the near term that could cause banking stocks to pop is some clarity on the European situation, which has dinged even U.S. financial institutions with no clear exposure to the troubles. "In our view, bank stocks will continue to exhibit abnormal volatility and a sustained rally will most likely elude the sector in the absence of a comprehensive and credible plan out of the euro zone," says Mr. Patten of Morgan Keegan. (Or, as Mr. Mitchell asks, "Where is the Ben Bernanke of Europe?")
So why invest in bank stocks now? Look at some valuation statistics from Barclays' Mr. Goldberg. He says the group of 32 large- and mid-cap banks he covers is trading at just over half its historic average ratio of price-to-tangible book. The group is at 8.9 times 2012 earnings estimates, with some of the bigger banks below five times earnings. The 20-year average is 13.2 times.
The 2012 earnings estimates are too high, you say? Cut them by 10 per cent, and the group is still trading at under 10 times earnings, Mr. Goldberg notes. Whack the estimates by 25 per cent, and the group still trades at a below-average 12 times earnings, with some big banks under eight.
In short, the group's prices reflect maximum fear. It is in that nether region where the biggest long-term profits are to be found.
David Milstead