Bank stocks were hit hard on Wednesday over fears that President Donald
won’t be able to carry out his economic and regulatory agenda. But solid fundamentals and reasonable valuations mean the outlook for lenders is still favorable.
Other sectors may need a sharp pickup in growth or deep tax cuts to go higher. But banks stand to benefit regardless from gradual interest-rate increases, their fat capital cushions and some relatively simple regulatory reforms.
Bank Index fell 4.1% on Wednesday, compared with a 1.8% fall in the S&P 500. It had been stuck in the doldrums for months after surging about 25% in the weeks following the election.
The banks have been stalled by uncertainty about Mr. Trump’s ability to ease regulation and boost growth. The rising din of conflict and scandal in Washington only lengthens the odds that Trump can achieve any of this.
Nonetheless, there remains a solid bull case for banks, based on trends that were in place even before the November elections.
First, the U.S. economy is growing steadily. Solid employment data continue to make a case for further rate increases by the Federal Reserve. These increases in short-term rates will be strongly positive for U.S. banks, since many loans are priced against short-term benchmarks like the London interbank offered rate.
Banks also have built up large excess capital cushions and can be expected to pay these out to shareholders in higher dividends and buybacks following this year’s stress tests.
Finally, there is an emerging consensus, even among Obama-era officials, that financial regulation has become too cumbersome.
the Federal Reserve’s recently departed point man on regulation and no darling of Wall Street, has himself opened the door to simplifying banks’ annual stress tests and loosening enforcement of the Volcker rule. The Trump administration could take action on both these fronts relatively easily without congressional legislation.
The KBW Nasdaq Bank index is trading at around 1.25 times book value. That is up from around one times book for most of last year.
Bank shares are unlikely to ever return to valuations of two or more times book, which prevailed before the financial crisis. But if the Federal Reserve continues increasing rates, and if the government delivers even the most basic deregulatory steps, there is upside left at current prices. That is still the case even if Mr. Trump’s grand promises fall flat.
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