US banks underperformed the broad market slightly in August 2024, for the third time over the last 4 months. Moreover, it was the 11th time of underperformance over the last 19 months. But the banks (BKX index) ended August in the green, for the second consecutive month. So, it was the 7th time of growth over the last 10 months.
EXECUTIVE SUMMARY
US banks underperformed the broad market slightly in August 2024, for the third time over the last 4 months. Moreover, it was the 11th time of underperformance over the last 19 months. But the banks (BKX index) ended August in the green, for the second consecutive month. So, it was the 7th time of growth over the last 10 months. Thus, BKX index increased by 1.2% MoM in August vs +2.3% MoM of the broad market (SPX index). Absolute August 2024 performance was +0.1 std from the mean monthly performance, and it was in the top 49% of absolute monthly performance in the index history. Relative August 2024 performance was -1.1% MoM. It is -0.2 std from the mean monthly performance, and it is in the bottom 42% of relative performance vs SPX index since the inception of BKX index. Despite a meltdown in the first decade of August, BKX index still has been outperforming the broad market ytd, +2.0% or +0.4 std. If the situation doesn’t change in 2H24, this year will be the first time of outperformance of BKX index over the recent three years. Just around a third of our sample ended August in the red. In turn, KEY and JPM, the best performers of August, increased by 5.8% MoM and 5.6% MoM, respectively. But regional banks were among the worst performers again in August, driven by a quite fast decline of rate expectations recently. A difference of monthly price changes between the best and the worst performers of our sample of banks was just 13.4% in August vs 28.2% in July and 8.9% in June. But June 2024 was the least volatile month for US banks over the last 70 months. In turn, 1Q24 was the most volatile start of a year since GFC. Moreover, correlation between price changes yoy and EPS FY24E changes yoy decreased slightly MoM in August, but still remaining quite high, staying at 45% as of the end of the month.
US banks continue trading with a discount both to historical averages and to the broad market, given quite weak performance of US financial institutions on absolute and relative bases in two recent years, even despite a noticeable decline of profit and revenue estimates. However, the discount narrowed considerably in July and August after roughly flat but volatile 1H24. Thus, median P/E 24E of our group of banks increased from 10.9x (as of June 28, 2024) to 12.1x (as of August 30, 2024). In turn, median P/E 25E went up from 9.4x to 10.8x for the same period of time. Hence, banks are still trading at just -0.2/0.0 std on P/E CY and at -0.4/-0.2 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages (as of August 30, 2024). As for valuations relative to S&P 500, the banks are currently trading at -1.14 std and -1.09 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively Median P/B of our group of banks was roughly flat in 2Q24, hovering around 1.17x. However, the ratio increased notably during the last month, rising from 1.17x (as of June 28, 2024) to 1.31x as of the end of August. So, on P/B, banks are trading already at +0.5 std from the sample mean (2010-current moment) vs SPX index with +2.2 std, despite the current adj. ROE premium to historical averages are roughly the same for both BKX and SPX indexes. As for individual names, multipliers are still quite different. But dispersion across banks (excluding NYCB) decreased notably ytd. Nonetheless, OZK’s P/E estimates for the nearest years are around 6-7x while MS’s ratios are 12-15x at the moment.
“The time has come for policy to adjust”. By these words at Jackson Hole the Fed’s chair Jerome Powell gave a clear signal of an inevitable start of the rate cut cycle as soon as possible. On the one hand, it wasn’t the news given a significant decline of the rate expectations in recent months. On the other hand, he was more dovish than expected, from our point of view, distinctly emphasizing downside risks to employment. As we wrote in our July monthly report, strong 2Q24 GDP beat shouldn’t be misleading. Yes, the US economy continued growing above expectations in 1H24. Thus, the US GDP growth accelerated to 3.0% in 2Q24 vs just +1.4% in 1Q24 and the initial consensus estimate of 2.0%. Moreover, the revision was driven by the key driver of GDP growth, consumer spending, which growth was improved from the initial estimate of 2.3% to 2.9%. In turn, real disposable income increased just by 1.0% during the last quarter. So, given that “labor market is no longer overheated, and conditions are now less tight than those that prevailed before the pandemic”, deceleration of GDP growth in the nearest quarters looks inevitable, even in case of a faster than expected decline of interest rates, which will still remain quite high for a significant part of the economy for some time. Thus, despite to a significant decline of rate expectations this summer, it is still implied that the Federal funds (FF) rate is expected to remain above 3% at least till the end of 2026. So, the most recent macro data points to growing imbalances in the US economy. Thus, key macro data revealed in August were mixed again with notably stronger retail sales and slightly higher consumer sentiment, in-line inflation data but weaker employment, industrial production and housing data.
The time is probably coming for EPS estimates to adjust somewhat. At least, revenue prospects modestly deteriorated recently, as the 2Q24 earnings season seemed to fully confirm our expectations about both ST and LT fundamentals dynamics. Thus, ST visibility of earnings deteriorated as of late because of higher macro uncertainty, which, among other things, also implying faster than expected reduction of interest rates. Nonetheless, given stronger 2Q24 earnings, EPS estimates have again resumed to grow recently. So, 3Q/4Q24 and FY25 EPS estimates still remained positive on a qtd basis as of the end of August even despite to a significant decline of interest rates. Moreover, our key expectation that 2Q24 was an inflection point both for NII and NIM still remained intact, even despite weaker than expected 2Q24 NIM figures (just 11 out of 28 banks from our sample, for which estimates were available, beat estimates in 2Q24). But it worth admitting that both the meltdown of interest rate expectations itself and the reasons behind it have worsened our view on near term NII dynamics. As well, a number of banks have already lowered FY NII outlooks recently. On the other hand, FY25 NII consensus estimates moved up both ytd and qtd. In any case, the recent cooling of the labor market as well as higher uncertainty about ‘soft landing’ imply lower loan growth as well as weaker credit quality even in case of lower rates. According to the Fed H8 data, total loans increased by 2.5% yoy (as of August 14, 2024) vs +2.3% yoy at the end of 2023. Moreover, any significant acceleration of loan growth isn’t expected in the near quarters. On the other hand, it isn’t expected any significant deterioration of credit quality either, even under the current baseline economic scenario. In turn, a notable decline of interest rates reduced securities losses, which for the industry came up around $700 Bn in 2H22, positively impacting on capital ratios, which, in turn, would add flexibility to capital management, implying higher capital returns, even in case of muted profit growth. In any case, OpEx still remained well controlled, and we believe that US banks will manage to return to positive operating leverage in 2H24, driven by resumed revenue growth on a yoy basis.
Revenue environment still remains challenging for US banks in ST, but LT prospects are less impacted by the rates decline. So, we still expect that FY EPS of US banks will return to growth in 2025 after three consecutive years of negative dynamics. In turn, positive EPS growth implies gradual re-rating of US banks, which continue trading at a notable discount to SPX index. Given still high but declining fast interest rates, US banks may remain volatile near term, but we still believe that banks may end 2024 year in the green on a relative basis. So, we remain bullish on the sector but recognize elevated risks.
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