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Wall Street is taking a pounding
(REUTERS/Carlos Gutierrez )
Lightning around the ash plume above the Puyehue-Cordon Caulle volcano chain near Entrelagos, Chile, in 2011.
US bank stocks have plummeted this year, and everyone wants to know why.
Morgan Stanley is down 30% from a year ago, while Goldman Sachs is down 13%. Wells Fargo is down 11%.
Deutsche Bank analyst Matt O'Connor has taken a stab at why that is in a recent note.
He cites multiple factors, including a weakening economy, tightening monetary policy, and credit concerns.
Here's the logic:
1. The slowing economy
O'Connor pointed out that nominal gross domestic product rose only 3% year-on-year in the second half of 2015.
"One could argue we are already in or near a recession — or at least are in a recession like environment (not all recessions 'feel' like a recession after all)," O'Connor writes.
2. Tightening monetary policy
Tightening monetary policy — that is, higher interest rates — might actually not be a good thing for banks. O'Connor writes that banks may have benefited from quantitative easing and low interest rates.
"During periods of QE, bank stocks rose 2.8% on average per month (vs. just +0.2% during non QE periods). In aggregate, gains during QE accounted for 91% of all gains in the BKX since Mar 2009," he says.
(Deutsche Bank)
Nominal GDP rose only 3% year-on-year in the second half of 2015.
3. Before the sell-off, bank stocks were not cheap
Before bank stocks peaked in July, they were trading above the historical long-term average "based on expectations that the overall economy was improving" and that "bank earnings would benefit disproportionately vs. the market as the economic growth accelerated."
So you could argue they had a lot farther to fall.
4. Banks aren't expected to earn as much this year
Earnings expectations for 2016 have dropped 10% in the past six months for market-sensitive banks, according to O'Connor.
The outlook could get even worse if we see weaker macroeconomic conditions — O'Connor says it could mean a risk of 20% to 25% in earnings per share if we see a slight downturn or mild recession. If we see a severe recession, which is unlikely, it could mean a potential downturn of 40% 50%.
5. Credit worries
In the fourth quarter, lending standards for banks tightened for the second consecutive quarter. Meanwhile, credit spreads are widening.
But O'Connor is not too bothered by concerns of credit quality.
"Within consumer lending, we've held the long time view that standards for mortgage and credit cards at the banks have been tight since the crisis," he writes. "As a result, we don't expect further tightening and wouldn't expect consumer credit to deteriorate much if there's a mild recession or near like recession in the US."
He does, however, see potential pressure in commercial and industrial loans, even outside the energy space.
6. It's normal for bank stocks to underperform the market at times like these
The whole market has seen a lot of volatility. And O'Connor's colleague David Bianco calculates that bank stocks have a beta of 2.3 times the S&P 500, which is in line with many other recent corrections. A beta is a measure of a stock's volatility compared with the volatility of the market as a whole.
(Deutsche Bank)
To get the must-read guide to the key issues at every major Wall Street bank, click here.
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