US Financials: Banking on Banks

• Improving loan demand has not yet helped Global Banking stocks as the sector has paused at resistance

• Messy near-term price-action comes amid more compelling long-term valuations

• US banks’ relative performance closely tracks 10yr Treasury rates

• In the US, the absolute valuation for the Financials sector is not exactly cheap, but relative valuations are near record lows

Betting on Banks

Global banks have posted a string of solid weeks after a pullback from early June through mid-July. The value play took a backseat to growth over the last few months as interest rates and inflation fears eased, but the recent upturn in the banking sector is a positive. Value investors took some solace in XLF’s 4 percent advance last week, the best among the eleven sectors.

World Banks’ Breadth & Internals

Taking a step back, World Banks stalled at long-term resistance while the Country Breadth 200dma indicator has declined (Fewer countries’ Banking sectors are above their 200dma versus several months ago.). This bearish divergence is not a positive sign, but we believe it to be more of a corrective pause than a significant top. We’ll be watching for a sustained breakout above the highs seen in the early to middle 2010s on the World Banks index.

We are also monitoring the internals of the World Bank index. Relative strength analysis among individual regions’ banking sectors suggests we have not yet seen a reliable bottom. Other market sectors remain in leadership for now across the US, EM Ex-US, and Asia ex-Japan.

Sector Valuation

While price-action and relative strength does not yet favor a short-term tactical overweight to Banks, valuations are compelling for a longer-term bullish thesis. Global Banks feature a median price-to-book ratio near 1.0x which is significantly cheaper than a basket of diversified global stocks. Relative value has been improving for many years (meaning cheap has gotten cheaper), so picking a bottom here is difficult, but the case for adding to the sector due to its valuation has grown stronger. How strong? The PE10 for Banks is at a ~60 percent discount versus the total market.

US Financials

Most investors are tuned in to the happenings in the US Banking sector. As lending standards ease amid strong demand for borrowing, banks should have a fundamental bullish backdrop in that slice of business operations. Our Weekly Macro Themes report takes a close look at how lending standards and loan demand are impacting the market.

As Go Rates…

As for domestic banks, all eyes remain on where interest rates are headed. US Financials’ relative strength is very dependent on the movement of the US 10yr Treasury Rate—when rates rise, XLF is the place to be, but falling rates correspond to weakness in the sector versus SPY. See 2021 as a perfect example. Our Chart of the Week shows just how close the relative performance of XLF tracks intermediate-term Treasury rates.

Chart: Financials' relative performance vs US 10-Year Bond yields

Is XLF Cheap?

Valuations for the US Financials sector are not cheap on a nominal/absolute basis. (Then again, what slices of US stocks are cheap these days?) Relative to the US stock market, the sector has a valuation Z-score composite about 1.5 standard deviations below its mean—that is about the most inexpensive the sector has been in the last 50 years.

Conclusion

We maintain a bullish view on Global Banks based on attractive valuations and a decent global backdrop. We see some near-term headwinds, so our bullish stance that began in May 2020 has softened somewhat. Despite the risks detailed in the Weekly Macro Themes report, the outlook for banks remains robust. Clients are encouraged to review the Bank Lending Standards analysis within this week’s report for additional color on the sector’s operating environment.

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