In mid July David Milstead wrote a column about banks using information from Bloomberg. President Trump in his first year and a half asked the banks which regulations they do not like and try to eliminate them, this plus the corporate tax sent bank shares higher. The result in the past was according to Chris Kotowski, an analyst with Oppenheimer & Co resulted in the banks becoming highly leveraged, heavily regulated, cyclical commodity companies with a history of blowing up every decade or so. Earning reports were beginning to come out in mid July and that is why the topic was chosen to be written about.

Mr. Kotowski noted bank stocks historically trade at 735 to 78% of the market P/E and at July 4th they were at 64%.  Bank balance sheets are probably less risky that any time in the past 30 years which should lead the shares upwards to their historical P/E ratios.

The problems include a new found focus on deposit beta or the proportion of changes in interest rates that banks pass along to their customers in the form of higher interest rates on deposits. Conventional wisdom is  banks can pass higher costs from the federal reserve raising interest rates, but the deposit beta tries to answer how well do they do it?In a June report, analysts at S&P Global Market Intelligence said the number averaged 19.6% in 2017, but it was 72.5% in the 4th quarter. They forecast 45% for the full year. Thus it seems the conventional wisdom is not fact.

Another concern is the yield curve between the 10-year Treasury and the 2-year Treasury is flattening. Peter Winter of Wedbush Securities says the yield curve has narrowed to its lowest level since before the financial crisis. It is note able that every recession in the past 60 years has been preceded by an inverted yield curve, which is why investors are focused on the shape of the yield curve.

RBC analyst Gerald Cassidy says investors should continue to own 3 types of bank stocks – Return on Capital (those that raise dividends and buy back shares); Risk On stocks (a more aggressive belief in the sector’s potential) and Multiple Revaluation (banks that should be favored as investors warm to their prospects.

examples Return on Capital – Bank of America, Regions Financial, Citigroup, M&T Bank, PNC Financial and SunTrust Banks

Risk On – Bank of America, Citigroup, JPMorgan Chase and Key Corp

Multiple Revaluation  PNC and BB&T

Linking to dividend paying stocks, it is very hard not to own bank shares in  your portfolio because as credit goes so does the economy. The previous administration put in regulations to keep the ability to leverage joined to earning the money back or with the money be repaid. Often times when banks have blown up, it is because many of the borrowers can not repay their loans or the risky part of the portfolio became too large. If a sector is trading below its historical average it may be a good time to buy, just do not use too much margin.

There are more questions than answers, till the next time – to raising questions.