Banking Sector Should Benefit from Overall Positive Indicators



Indicators are generally positive

A rise in interest rates is expected to be a key catalyst in the growth of the banking sector. It’s widely believed that the hike may not come at the FOMC’s (Federal Open Market Committee) upcoming June meeting. At the same time, indicators such as the slope of the yield curve, the unemployment rate, and loan losses are moving in the right direction. A not-so-positive indicator for the sector is the persistently low inflation level.

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Loan growth at banks: Mixed signals?

Expansion in manufacturing should boost commercial and industrial loan growth at banks. The slip in industrial capacity use in April, however, is a negative for banks. You can read more about it in Industrial Capacity Use Slips Again: Will It Hurt US Banks? The capacity use data for May are scheduled to be released on June 15, 2015.

Optimism in the housing sector and a surge in mortgage applications should support residential loan growth. The growth in housing starts, too, is a positive for residential loan growth. You can read more in April Surge in Housing Starts Should Benefit Banks. The housing starts data for May are scheduled to be released on June 16.

Higher income and employment rates should benefit consumer loan growth at banks. Stagnant consumer spending, despite higher income, doesn’t help consumer loan growth at banks. Consumer spending is, however, expected to increase going forward.

Sector return on equity is below pre-crisis levels

The ROE (return on equity) for all US commercial banks for the fourth quarter of 2014 stood at nearly 9%, according to the latest reported data from the Federal Financial Institutions Examination Council. Though significantly improved since the 2008 financial crisis, the sector’s ROE is still way below pre-crisis levels. The above graph shows the ROE for all banks since 2004.

The banking sector is undervalued compared to the broader market. It should do well going forward and attain higher ROE and valuations.

In terms of ROE, Wells Fargo (WFC) has been outperforming other big banks such as J.P. Morgan (JPM), Bank of America (BAC), and Citigroup (C) for quite some time.

Together, these four banks form ~27% of the Financial Select Sector SPDR Fund (XLF).


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