Here’s a question for you. Does news lead stocks, or do stocks lead the news?
The market is abuzz today about Trump’s plans to roll back financial sector deregulation. Bank shares soared in the US on Friday, and Aussie banks should do well today too.
The Wall Street Journal has the story…
‘The six biggest U.S. banks could potentially return more than $100 billion in capital to investors over time through dividends and share buybacks if the Trump administration succeeds in
a push to loosen bank regulation.
‘President Donald Trump on Friday signed a memorandum ordering a review of the Dodd-Frank Act, the postfinancial-crisis regulatory overhaul that has guided regulators such as the Federal Reserve. The aim is “cutting a lot out” of those rules, President Trump said in a meeting at the White House.’
Less regulations means bank executives will take on more risk. But it won’t blow up for a few years yet. It will take time to dismantle the rules. And, at this point, no one knows exactly which rules will stay and which ones will go.
Although, clearly, the market expects the banks to return capital in some form or other down the track. But less capital means more leverage. And more leverage means higher risk. Once again, that won’t be an issue for a few years to come.
But it certainly does set things up for the ‘next’ crisis.
Beware the doomsayers
On that note, beware those who claim the dismantling of the Frank-Dodd Act will lead to imminent financial disaster. It won’t. It takes time for the culture of risk-taking to change.
For example, it took time for ultra-low interest rates in 2002/03 to feed through to the insane sub-prime mortgage crisis. Visible cracks didn’t start to appear until early 2007. And even then, the market keep moving higher, ignoring the signs until it was all too late.
Now, let’s get back to my initial question. Does news lead stocks or vice versa?
Have a look at a chart of the Philadelphia Bank Index…
Click to enlarge
As you can see, bank stocks moved sharply higher as soon as Trump won the election. That was because investors had already started anticipating a relaxation of financial regulations.
Now that Trump has formally requested a review of the Frank-Dodd Act, the market only moved a little higher (the bank index was up 2.24% on Friday). As you can see, the market moved in anticipation of the news.
This is a general rule for just about any market or stock. Prices always move ahead of the news. When the news hits the headlines, you can be almost sure that it’s already in the price and there isn’t much of a way to profit from it…not in the short term at least.
Looking at the chart, you can see that US banks stocks are in a firm uptrend. The rally from early November to December was so sharp, it’s natural for the market to now move sideways for some time. It’s ‘consolidating’ the move higher.
But I think it’s just a matter of time now before stocks break higher again. There is no bear market on the horizon. The US is a heavily financialised economy. If it’s in trouble, you’ll see that show up in financial/bank stocks first.
Based on the price action over the past few months, there is simply no sign of it.
Aussie banks look bullish
What about Aussie banks?
They are getting a very good Trump boost too. The chart below shows the ASX 200 financials index over the past 12 months…
Click to enlarge
As you can see, investors sold Aussie banks in the lead up to the US election. When Trump gained his surprise victory, banks sold off sharply, before an immediate and vicious reversal sent them higher.
From the nadir to the peak in early January, bank stocks soared 22.5% in two months!
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If I had to guess though, I’d say that the index will spend some time moving sideways before it takes out new highs again.
Aussie banks have had a tremendous run in terms of profitability over the past decade or so. In fact, the big four banks are probably the most profitable in the world. This is in contrast to US banks, which saw profitability crunched by the financial crisis. They have not really recovered since then.
When I say ‘profitability’, I am referring to return on equity (ROE). When ROE increases, share prices usually do too. Likewise, when ROE falls, share prices fall.
Because Aussie banks already generate relatively high ROE, it will be harder for them to get another leg up. US banks on the other hand are coming off a low base.
As an example of the headwinds facing Aussie banks, this morning, NAB reported a 1% decline in year-on-year profits for the December quarter. Rising costs dragged the result lower.
While a 1% decline isn’t anything to worry about, it’s not growth. And in the stock market, growth is everything. The market doesn’t seem too concerned about the result today though. NAB’s share price is up thanks to the Trump tailwind.
The mood of the market is clearly bullish. It’s looking ahead to better days. Old news is exactly that.
Don’t forget, the market ALWAYS looks ahead. Often, we don’t know what it’s looking at. We can’t understand what it’s so excited about. But more often than not, the market is right.
So if the market is bullish, you should be too.