Banks

Plunging commodities have been driven by increased supply and falling investor demand, not a major downshift in physical demand. Stay neutral global equities. The earnings outlook remains uninspiring, but bottoming oil prices and continued monetary stimulus support valuations. The selloff in global bank shares reflects NIRP-related "income statement worries", not "balance sheet concerns" linked to deteriorating credit quality. Downgrade Treasury notes to neutral. The rally in bonds has brought 10-year yields near our long-standing, out-of-consensus target of 1.5%. 

Bank stocks have been under significant pressure of late, but we continue to caution against any temptation to bottom fish. The ballooning in the number of corporate bond downgrades is signaling a surge in non-performing loans. It will be difficult for valuations to expand when non-performing loans are climbing and global economic growth remains below-potential. The chart shows a cycle-on-cycle analysis of bank stock relative performance during periods of deteriorating credit quality. We proxy the latter using overall corporate bond spreads, which have leading properties for non-performing loans, only with much more historic data. History is clear: when the credit cycle turns, the implication is a higher risk premium for lenders. Against a backdrop of increased credit stress and rising corporate bank bond spreads, loan loss reserves are likely to accelerate. The upshot is that low bank stock valuations are likely to persist. The ticker symbols for the stocks in this index are: BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION.

Economic disappointment represents a serious obstacle for stocks. Stay with non-cyclical plays, including telecom services and health care. Upgrade the managed care group, and stay clear of banks, regardless of cheap valuations.

An improvement in the euro area credit impulse is encouraging, but we explain why it is not enough to sustainably boost risk-assets.

A recent article in Barron's painted a bright picture for bank stocks, but we have a more cautious view. While value is attractive, the earnings picture has darkened. The narrowing yield curve and budding downturn in credit quality will put pressure on credit creation to drive profitability. However, we are skeptical that loan growth will improve much. The latest Fed Senior Loan Officer survey showed that banks continue to tighten standards on both C&I and commercial real estate loans. While they remain willing to make consumer and mortgage loans, demand for a number of these categories is drying up. Against a backdrop of increased credit stress and rising corporate bank bond spreads, loan loss reserves are likely to accelerate, warning that low valuations are likely to persist. We recommend only a market neutral weighting. The ticker symbols for the stocks in this index are: BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION.

Bank Credit Analyst

The U.S. corporate re-leveraging cycle is far more advanced than is widely believed. Corporate health looks only mildly better excluding the troubled energy and materials sectors. Mushrooming leverage ratios are not restricted to junk issuers either.

Equity selloff alone will not catch the Fed's eye unless there is an outright crash.