The second half of 2018 saw a litany of items fueling uncertainty in the markets as the year closed out and the federal government shut down. In no particular order: Rising rates further flattened the yield curve and raised the specter of a possible recession-predicting inversion of the short and long ends of the curve; Trade tariffs and the potential for unintended consequences (particularly with China) across broad cross sections of our economy added more volatility to the equation, as markets spiraled and investors parsed information in an effort to get any sense of direction. This activity also seemed to underscore some early-stage weakening in the global economy (and continued uncertainty tied to geopolitical risks and possible disruption surrounding the Brexit redux), and what those implications might mean for the United States. As we’ve touched on in recent months, we are now 10+ years into this economic expansion (albeit it was a bit anemic in the first seven to eight years), and banks are clearly more focused (while always cognizant) of the next turn in the credit environment. All of the above, and additional cautionary macro-factors, seemed to feed into a dramatic hit to financial sector equities in the latter stages of 2018, especially the last few months.
The above depicts that major market indices and our nation’s largest institutions clearly thrived in the post-election environment, but then declined rapidly in the latter half of 2018, before witnessing a hoped-for, early-stage rebound in 2019. If we simply isolate the last month of the year, the DJIA dropped approximately 10%, while the KBW Bank Index saw a decline in excess of 15%, as many banks across all asset sizes were pummeled. In my equity research days, these kinds of dynamics in this type of trading environment sometimes signaled that earnings estimates could be a tad high. Consequently, the sell-off might indicate that revisions were on the horizon, and the market was effectively getting out ahead of probable changes to an existent, more optimistic growth trajectory for bank stocks. A recent Wall Street Journal article touching on volatility in both bank stocks and earnings estimates seems to succinctly capture the sentiment:
“Positive surprises may be dismissed by investors as irrelevant, since they are worried about future economic performance. On the other hand, any negative surprises could be taken as confirmation that things are headed in the wrong direction. Expectations have fallen for banks, but they may not be low enough.” (WSJ, “Good Volatility? Don’t Bank on It”, January 12, 2019)
So, while even Michigan’s largest publicly traded banks did not escape the year-end 2018 carnage in the sector, the resilient fundamental profiles of these institutions might be worth revisiting given the downdraft and resultant valuation metrics.
One of our talented and seasoned senior associates, Matt Wainscott, brought to my attention the graphic nature of the whipsaw-like trading downturn in bank equities toward year end, as reflected in the above charts, as well as the subtle rebuilding in the stocks in the opening weeks of 2019. In the “a picture is worth a thousand words” category, he recommended a few simple graphics to depict the underlying analytics: bright sunshine and blue skies for the first block of data to the far left (performance post-election through last summer) that was virtual nirvana fueled in large part by tax reform and the early stages of constructive regulatory relief; looming storm clouds and ominous lightning strikes for the middle block (performance beginning last summer through year-end 2018) that reflected both volatility and uncertainty building as the year was coming to a close; and then a more peaceful sun-scape sitting on the horizon in the block to the far right (performance in the opening two weeks of 2019) that reflects some semblance, even if tenuous, of stability as equities have modestly recovered a portion of the recent beat down.
With regard to that last year-to-date pictorial, we both agreed that the sun nestling calmly on the horizon would probably be appropriate in reflecting a somewhat positive general narrative concerning underlying economic fundamentals. However, we couldn’t agree on whether or not this picture would represent a sunrise or a sunset? Effectively, translating the metaphorical context, would a “sunrise” represent the next leg of continued economic expansion and commensurate market gains for the banking sector, or, would a “sunset” serve as a harbinger of the emergence of interest rate-related and credit-driven headwinds that might signal we are nearing the end of the current economic cycle? Only time will tell. One of my latent concerns is that never-ending, drum beat-like talk of a recession manifests itself as a self-fulfilling prophecy.
All eyes will undoubtedly be focused on year-end earnings releases over the next few weeks, while we listen attentively to pertinent commentary coming from bank leadership as to what they see on the horizon, and how they expect 2019 and beyond to play out. It is important to keep in mind that even with this backdrop of somewhat disconcerting activity and stressful news headlines, the economy (as measured by GDP growth) continues to expand at a healthy pace, and unemployment remains at or near historical lows. However, significant late-cycle loan growth has rarely ended well and could prove problematic if we are closer to a downturn.
As we opined last month, 2019 promises to be another interesting year for the industry and, depending upon the direction and magnitude of interest rate changes and shifting economic dynamics, it seems it could also possess challenges that may intensify as the year unfolds. I am confident that the state’s banking organizations are up to the task. Equity levels continue to be robust, most leadership teams have been battle-tested, risk management architectures have strengthened noticeably since the crisis, and ideally the Fed can help choreograph a more modest, and short-lived economic slowdown when it surfaces somewhere down the road. And when it comes, additional comfort can be taken in levels of pre-provision income and capital support at banks that is clearly much stronger since the Crisis.
I take some solace in recent comments coming from Fed Chairman Powell, notably that the central bank “will be patient” (January 4), followed by the Fed “is waiting and watching” (January 10). Such commentary seemed to soothe investors’ fears of managed rates continuing to rise even if economic growth slows, as it signaled a notable shift in sentiment that the Fed intends to rely on more data-dependent decisions going forward. Inflationary pressure has not yet emerged and reared its ugly head, even as wages begin to tick up. Economic cycles are inevitable. Ideally, as we’ve stated in the past, they just need not be catastrophic. The hope that when the next recession does surface, it will be both relatively mild and short-lived by historical standards.
In closing, attached please find our monthly summary of Michigan’s financial institutions. As you and your Board take your organization forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of any assistance in helping you assess the competitive landscape. I look forward to re-connecting with all of you as 2019 unfolds.
JANUARY 2019 MICHIGAN BANKING SUMMARY
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