Analysts following the stocks of large U.S. banks, which own major broker-dealers, are generally bullish on the sector for 2017.
Though technology challenges and economic unknowns naturally present risks for the sector, the positive factors that have propelled the group up about 50% since June’s Brexit vote will likely be more influential in the year ahead, they say. Plus, other circumstances—such as the election of Donald Trump—bode well for it in the year ahead.
The reasons behind this positive outlook include broad and specific drivers in the financial system, according to Richard Bove, vice president of equity research for Rafferty Capital, and they encompass the bank’s broker-dealer operations.
Analysts at Keefe, Bruyette & Woods agree: The group “still has room to run as rates move higher, the trading environment improves, modest deregulation decreases company-specific risks, and the U.S. sees better nominal growth aided by a strong U.S. consumer,” according to a recent report by analysts Brian Kleinhanzl and Michael Brown, CFA.
Looking at President-Elect Donald Trump’s policies, Bove points that there could be tax cuts in 2017 to incentivize greater corporate spending. “There also could be $2 trillion repatriated through a government program to bring back profits held overseas,” Bove explained in an interview.
Ultimately, he says, a decent amount of these repatriated funds should end up as bank deposits. He also sees at least a small amount of fiscal stimulus on the horizon.
The team at KBW says it sees large-scale deregulation or tax reform on the horizon, and the large banks “would be a major beneficiary if either were to occur.”
Three Key Assumptions
Looking at these general trends in more depth, Bove argues that three conditions will further support the sector in the year ahead.
“First, there’s going to be a huge need for money,” he explained, “if the government is going to stimulate the economy to build bridges and tunnels.” The public sector will do some of borrowing to finance these programs, he says, and will “move to involve the private sector to do so as well.”
“There should also be tax cuts to incentivize growth in the economy,” Bove stated, “and, again, that entails lots of bank lending.”
If tariffs are put into place to stimulate manufacturing, that policy move also will be associated with increased bank lending, the veteran banking analyst says.
“For bank earnings, the main source is loans. And all indications are that they are going to go up,” he added.
The KBW analysts forecast median loan growth of 4.9% in 2017 and 5.1% in 2018—in-line with their nominal gross domestic product (GDP) growth expectations.
The Fed, Rates
The Federal Reserve, equity analysts say, is poised to raise rates in 2017.
“I personally do not believe they will move again for six months or longer but will move sometime in the next 12 months,” said Bove. “Then, essentially we are looking at higher margins on loans being created.”
Thus, “It’s the best of all possible worlds for banks,” he explained. “They will be selling more products at higher margins.”
Another factor supporting the bank is an increase of energy loans. “With energy demand expected to go up in 2017, energy loans that were in the process of being written down [due to low prices] would be written back up. And that, too, should boost bank earnings.”
Loan growth and margin improvement should produce better revenue growth for the big banks than the group has seen in recent years, KBW argues. “We expect [the large] banks to grow revenues by 4.7%, on average, in both 2017 and 2018, and we expect companies to sustain expense discipline as well—thus, much of the benefit from higher rates should drop to the bottom line.”
Bove insists the dollar, interest rates and economic vibrancy should all continue to rise. “Then the balance sheets of the banks and other companies will adjust [accordingly] to meet the new economic and financial environment.”
His outlook includes “a huge increase in trading,” along with a “big jump” in initial public offerings and mergers and acquisitions.
Plus, Bove thinks banks’ price-to-earnings multiples “are not out of line with their 15-year history… The banks should do phenomenally better, while the market could do somewhat better.”
The bank analysts with KBW view valuations as “still reasonable at current prices,” but they argue that investors “should be selective in how to position for the future and … not [buy] …the group blindly.” For instance, it has an “outperform” rating on Bank of America, JPMorgan, Goldman Sachs and Bank of New York Mellon (which owns Pershing).
“We believe the largest risk to cause banks to underperform is credit deteriorating faster than expected, but it is hard for us to see where that could happen given our current macro outlook,” they explained in a report issued Dec. 6.
What is Bove’s view of where results for the broker-dealer units of the banks are heading? “They, too, should be positive, particularly when considering the wave of equity offerings” in the pipeline, he explained.
Demand for equities is up, but the supply of equities is not. “We could see a huge wave of offerings in 2017,” the veteran analyst said. “Supply will grow on demand …,” he concluded. “And the outlook is terrific.”
See ThinkAdvisor’s Outlook 2017 landing page for more insights for advisors on the economy and markets in 2017.