Annual stress testing is performed on banks. Next year, bank investors will have to deal with their own issues.
Few people believe the industry will collapse. It's all about how it ranks as an investment heading into the new year. On the good side, the https://liquidity-provider.com/news/think-the-federal-reserve-is-already-tightening-not-so-fast/ is projected to hike interest rates, enhancing bank profitability. However, the industry is expected to face increased regulatory scrutiny, which might impair performance.
While passive sector investors have been rewarded in recent years, owners may need to be more selective and take an active stock-picking strategy in 2022. The SPDR S&P Bank exchange-traded fund (KBE) has risen 111 percent since the market bottom on March 23, 2020, significantly outperforming the S&P 500, which has gained 103 percent.
This kind of "rising tides raise all boats" performance is unlikely to happen again. Banks are in good shape, with the largest ones passing all of their yearly stress tests as well as the pandemic's very serious testing. But the catalysts for growth are murky. The pandemic recovery trade is gone. Banks can no longer rely on strong trading revenue and uncertain dealmaking prospects. The most likely growth drivers are rate rises and loan activity, albeit not all banks will profit equally.
According to Abbott Cooper, founder of Driver Management, a bank-focused investment business, investors should look for banks with varied income sources and solid management teams. He mentions JPMorgan Chase (JPM) and SVB Financial Group (SIVB), situated in Silicon Valley. Neither of them could be accused of being cheap. SVB Financial, which has a lot in common with its tech start-up clients, trades at 3.4 times tangible book value, whereas JPMorgan trades at 2.3 times tangible book value. According to FactSet data, peers trade around 1.9 times.
"Regardless of industry, economic, or other conditions, the two banks' management teams will find a way to create greater long-term returns for investors," Cooper told Barron's.
The Fed's ambitions to raise interest rates are first and foremost on investors' thoughts. To keep inflation under control, the central bank said it would raise rates three times next year. Bank earnings benefit from rate rises because loans become more profitable, but the interest banks payout on deposits does not rise as quickly.
However, increased profitability does not always equate to higher stock performance. Adviser Investments' Charlie Toole compared the performance of bank stocks to the S&P 500 over four rate-hiking cycles beginning in 1994. Banks underperformed the broader market in every case but one, regardless of whether the performance was assessed from the first to the final rate rise or from the first hike to the first reduction. Underperformance varied from a minuscule 0.3 percent during the rate-hike cycle of 2004-06 to a far more dramatic 27 percent in the run-up to the dot-com bubble's bursting.
Bank stocks will also confront a more subjective threat in the coming year: regulatory pressure. It remains to be seen if this pressure results in policy, but the industry might be targeted when appointments are made and politicians campaign for midterm elections.
The Fed's vice chairman of banking supervision will be nominated by President Biden soon. Other available regulatory positions include the top job at the Office of the Comptroller of the Currency, which has been vacant since Biden's first candidate, Saule Omarova, resigned after meeting Republican and moderate Democratic opposition.
Some investors are concerned that Wall Street watchdogs would enforce stricter capital regulations, lowering shareholder payments, increase regulatory scrutiny of bank acquisitions, and increase pressure on banks to address climate change. Many hooplas in Washington might eat away at stock performance for investors. However, for certain banks, this may indicate a purchasing opportunity.
"There are always great opportunities to acquire quality names as the sector reaches air pockets," Cooper adds. "When investors get worried about macro problems, the sector actually trades as one, and a lot of babies are tossed out with the bathwater."
Cooper loves Pinnacle Financial Partners (PNFP), BancFirst (BANF), ServisFirst Bancshares (SFBS), and Pinnacle Financial Partners (BANF), in addition to JPMorgan and SVB Financial.
Western Alliance Bancorp is a financial services company based in the United States (WAL). Since 2015, none of the names appear inexpensive, yet they've regularly generated significant returns.
The compound annual growth rate is Cooper's favorite statistic since it demonstrates how well banks can perform over a longer period and in tough situations. According to FactSet, SVB's stock has returned a spectacular 28 percent compounded annual return since 2015. ServisFirst is in second place with 27%, while Western Alliance is in third place with 21%. Others, such as JPMorgan Chase and Pinnacle, are at 14% and 13%, respectively, while BancFirst is at 12%. The average rate in the industry is 7.1 percent.
Being picky might pay off for bank investors.
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