Banks stocks may join cyclical stock rally; yield curve steepening, return of inflation to help


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Financials stocks are likely to participate in any cyclical stock rally triggered by yield curve steepening, according to Chris Wood, global head (equity strategy), Jefferies. In his weekly newsletter, the market strategist said that financials may join the rally as has already happened with the likes of European and Japanese banks.The EuroStoxx Banks Index has risen by 45% since late October, while the Topix Banks Index is 21% above its March lows. However, if the Federal Reserve, and other G7 central banks, suppress the steepening of yields by pegging bond yields, that may turn out to be a long-term issue for banks.

“Remember that in Japan the 10-year JGB yield is pegged by the Bank of Japan, which is a reminder why the longer-term issue for bank stocks is whether the Federal Reserve, and other G7 central banks, suppress that steepening by also pegging bond yields in line with GREED & fear’s long standing base case,” he said. Chris Wood cited a report by Jefferies senior European banks analyst Joseph Dickerson and highlighted that bank stocks will be a natural beneficiary if the policy response to Covid-19 triggers the peakingout of the nearly 40-year-long deflationary era and the return of inflation.

Broad money supply has increased in the G7 world as it moves from a disinflationary era to an inflationary one. The money has been flooded in by guaranteed lending schemes. The US M2 — a calculation of money supply — has surged from 6.7%on-year in December 2019 to to a record 25.3% on-year in mid-November. Loans extended by the United Kingdom in the coronavirus lending scheme totaled £66.4 billion as of 15 November.

Chris Wood adds that investors should assume, until proven otherwise, that these loan guarantee schemes remain in place long after the pandemic has passed. “What about the bank stocks themselves? Dickerson continues to argue that the banks can make more money on these guaranteed lending schemes than by doing what they would normally do in an economic downturn, namely buying government bonds,” he added.

Although risks do stand for banks in the long run as they become service agents for governments and with risks aligned with guaranteed lending even by a ban on dividends. “In the short term, banks can outperform on the yield curve steepening that should accompany any further post-pandemic return-to-normal trade,” Chris Wood noted. The report he cites further adds that there is more than 60% upside in global bank stocks for mean-reversion back to a 20-year mean relative to the MSCI AC World Index.


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