The late 2019 rally in US bank share prices is likely to run out of steam early this year, investors and analysts warn, even as three of America’s top five banks prepare to announce double-digit increases in their fourth-quarter earnings this week.
Banks were among the best performers in the US stock market in the fourth quarter, with the largest five posting average share price gains of almost 17 per cent in a period when the diversified S&P 500 index rose more than 8 per cent.
For 2019 as a whole, shares in JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup and Bank of America rose an average of 38 per cent, while the S&P index gained 29 per cent.
“I certainly don’t think the trajectory of the improvement in [banking] stock prices in 2019 is sustainable,” said Andy Braun, a portfolio manager at Impax Asset Management, arguing that last year’s rise “reflect how discounted [banking] stocks were at the beginning of 2019”.
Banks entered the year weighed down by idiosyncratic concerns, including fears Goldman would be hit by a massive fine for its role in the 1MDB scandal, and industry-wide ones. These included recession fears, banks’ failure to grow loans, and a flattening of the US yield curve earlier in the year.
JPMorgan was the only one of the five banks that began the year with a market value that was higher than the book value of its assets, reflecting its status as US banking’s leader in the post-financial crisis era. This week’s fourth-quarter earnings will give an update on the book value of the banks’ assets. It will probably show that Bank of America now has a market value in excess of the value of its assets, based on the bank’s year-end share price and its expected fourth-quarter results.
Citigroup, which began the year trading at about 70 per cent of its book value, probably had a price to book value of more than 90 per cent by the end of the year, while Goldman Sachs probably improved its price to book value from a starting point of less than 80 per cent to more than 95 per cent.
Last week analysts at UBS downgraded JPMorgan from a “buy” to a “neutral” rating, claiming “substantial share outperformance” meant there was no longer “sufficient upside” to the stock. JPMorgan’s shares rose 40 per cent last year, and the bank had a price to book value of 156 per cent at the end of the third quarter.
“We’ve gotten back to fair value or thereabouts,” Mr Braun said. “Looking forward, banks don’t necessarily have the Federal Reserve as a tailwind, which they had at the beginning of last year,” he added, referring to the benefits from interest rate rises in late 2018 that flowed through to early 2019 profits.
JPMorgan, which kicks off the banks’ earnings on Tuesday, is expected to report a 12 per cent increase in quarterly net income versus a year earlier, according to analysts polled by Bloomberg. Morgan Stanley, which closes the earnings season on Thursday, is expected to post a 37 per cent rise in net income year on year, while Goldman Sachs is set to report a 13 per cent improvement.
The big jumps are driven largely by flattering bases for comparison, reflecting how investment banks typically experienced a tough fourth quarter in 2018, when their businesses were battered by chaotic markets. Executives at Bank of America, JPMorgan and Citigroup have already told investors that their trading and investment banking businesses had a strong end to 2019, including a “high teens” percentage increase in revenues at Citigroup’s trading unit.
Retail banking will show poorer results since interest rates are lower than they were a year ago, making it harder for them to produce profits. Senior executives including JPMorgan chief financial officer Jennifer Piepszak have said the US consumer remains strong and banks are not yet seeing issues with loan defaults.
“I think upside for most of the stocks is only about 5 per cent to 10 per cent,” said hedge fund manager Douglas Kass of Seabreeze Partners Management of the outlook for bank stocks this year.
He predicted that commercial and industrial loan growth would be “sluggish and constrained by the length of the economic cycle — now going into the 11th year”. He added: “Earnings per share will be buoyed by continued buybacks as the industry is vastly overcapitalised.”
Those repurchases were a key factor in 2019’s share price increases, as the big five banks collectively spent more than $57bn buying back stock.
Jim Paulsen, chief investment strategist at The Leuthold Group, an independent research firm, said the banking sector’s share price rally would continue if the interest rate environment became more favourable, economic growth improved, stock markets generally rose and credit spreads tightened.
He believes financials are still “under-owned in most portfolios” and with better earnings, “you could see portfolio flows head their direction”. This would also support continued share price growth, he added.