A new dawn for US banks?

The election of Donald Trump as US president may mean that the post-2008 era of tight regulation and low interest rates is drawing to a close, with interesting consequences for US-listed bank stocks. 

Federal Reserve
Source: Bloomberg

The S&P bank ETF has gained 12% since Donald Trump’s election, and while some of this euphoria will fade, it is not impossible to believe that the long rally from the lows of 2009 has entered a new phase.

The bullish case for US banks is built on the idea that we are entering an era of higher interest rates, coupled with a president that is keen to roll back some of the legislation enacted in the wake of financial crisis. The new administration has made noises about lifting some regulations, with the Dodd-Frank provisions mentioned during the course of last week, which may be why the sector enjoyed such a strong move.

Of course, actual detail is still lacking, and may be for some time, but one possibility is that the minimum asset threshold for banks designated as ‘too big to fail’ (TBTF) is $50 billion. If this is lifted to $250 billion then many US banks might find themselves outside of the TBTF designation, giving them more capital to expand their businesses.

For the biggest banks, a limiting of Dodd-Frank provisions could allow the return of some activities such as proprietary trading, while a reduction in regulations would reduce costs and increase profitability, raising the prospect of higher dividends.

On the interest rate front, a period of higher inflation caused by increase infrastructure spending and tax cuts could see the Federal Reserve having to move more quickly, and more dramatically, than many had expected. Global banks have seen their profitability hit by record-low interest rates, but with the Fed already talking about raising rates (after a hike in December 2015), investors were on the lookout for any sign that further rate increases were on their way. Indeed, data has shown that ETFs tracking financial stocks saw seven consecutive weeks of inflows in the period to 9 November, a phenomenon that may accelerate now that Donald Trump has won and talk of stimulus is in the air.

At present US banks currently trade at around 11 times forward earnings, versus a low of 9 times in February 2016. At the peak of the crisis, the sector traded at over 33 times earnings. A removal of regulations could see banks due for a re-rating, particularly if Trump also succeeds in boosting US economic growth through his stimulus plans.

We can use the price chart of the SPDR S&P Bank ETF as a representation of the broader index. The price moved above 4000 this week, its highest level since the beginning of 2009, and above the high of 3725 that was seen in 2015. At present the price is heavily overbought, so for the time being it may be best to wait for a bigger pullback. Nonetheless, buying on the dip would seem to be the approach here, especially if the new administration’s policies begin to match expectations. 

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