Banking sector facing good news/bad news from macro trends
Given the rebound in the Financials sector’s relative returns recently, and the broader increase in investor interest in Value after a long period of underperformance, it’s worth a look at some of the macro trends in the US banking sector to help identify trends that affect profitability. The data show both good news and bad news for the banking sector.
We first dig into the quarterly data on the US banking sector released by the Federal Deposit Insurance Corporation (FDIC), currently as of the end of Q3 (Sept. 30th, 2020), shown in the chart below. The top section shows the total assets of all FDIC-insured institutions in the US (about 5000 institutions), currently about $21 trillion.
Energy sector has rallied, but optimism is already high on crude oil
The recent returns of the Energy sector have been dramatic: in just two weeks from its latest trough on November 6th (just before the Pfizer vaccine news hit), the S&P 500 Energy sector rose 37%, the biggest return of any of the major sectors by a wide margin. The overall S&P 500 index, meanwhile, returned only 3.6% in that period. Most recently, the gains in Energy have cooled somewhat, but the sector (as of Dec. 2nd) is still up 30% from its November 6th level, well ahead of all other S&P 500 sector returns over the period.
Small-caps are gaining traction as light appears at the end of the COVID tunnel
After a long period of either underperformance or mixed relative returns, small-caps in the US are now finally gaining meaningful traction relative to large-caps.
As shown below, the relative return of the small-cap Russell 2000 index versus the large-cap Russell 1000 index has broken out of the range it has been in since June. The latest move started after the Pfizer vaccine news hit on November 9th, after making an initial move in early October.
Vaccine news brought record style rotation in stocks
The headlines on Monday (Nov. 9th, 2020) from Pfizer announcing favorable early results in their COVID-19 vaccine trials, while certainly welcome, clearly caught investors off guard. While the major indices were either up or flat on the day, there was a historic level of divergence within the market among the various styles and sectors.
Such extreme rotations remind us that there is risk in the equity markets even when stocks overall do not fall. Investors focused on relative performance likely either had a huge win or huge loss on Monday.
Politics aside, earnings estimates are still improving
While the headlines and market reactions are dominated by the US election results right now, it is worth keeping in mind the news on corporate earnings trends. More than 75% of companies have now reported Q3 earnings, and the results have been extremely strong relative to expectations. The results have not, however, been immediately greeted with positive price responses. Market action being attributed to the election may also be influenced by a lagged response to earnings reports.
Big divergences in commodity space still favor Materials over Energy
One of the themes in our sector research for clients recently has been to focus on relative preferences within broader style or macro categories, rather than making big macro bets on Growth versus Value or Cyclical versus Defensive areas. We find that in a more range-bound market with conflicting macro trends, a more granular view is often more effective.
One stance we have held for some time has been within the Value-oriented commodity space. While in many cases historically the Energy and Materials sectors have moved together, this year has seen a dramatic divergence between the two commodity-related sectors. We have favored Materials over Energy this year, and still do, and below are some of the drivers of that view.
Housing has been strong, but mortgages are harder to get
By some measures, the US housing market has been extremely strong. Sales of new homes are up more than 30% year-on-year, as many people are seeking to leave big city centers and buy single-family homes in the suburbs.
However, the chart below shows some of the extreme and offsetting influences on the housing and mortgage markets right now.
Online shopping trends remain a key driver of equity returns
The growth of online shopping has been well-established for years now, but the pandemic has prompted an acceleration in that trend, which continues to be felt in relative stock returns.
The chart below shows the year-on-year growth rates of total US retail sales and online retail sales (non-store retailers) over the last five years (based on monthly retail sales reports from the US Census Bureau). We can see that online sales have been growing significantly faster than total sales the entire time, and most notably, are now near their highest growth rate (20%+) even as total retail sales dropped sharply earlier this year and are currently roughly unchanged from year-ago levels (indicating that non-online sales are down from a year ago).
Putting the Fed’s balance sheet in perspective
Along with fiscal stimulus, the aggressive support of financial markets by the Federal Reserve (and other central banks) has been a key to the gains in risk assets since April. In our view, stock and bond prices would not be as high as they are if not for the perception that the Fed will step in with additional support if markets get too volatile. This perceived “Fed put” is on top of the ongoing bond buying programs (excluding the immediate post-COVID surge) that are currently running at a rate of about $80 billion per month for Treasuries and $40 billion per month for mortgage backed securities, though some of this replaces expiring bonds.
Tech Sector In The Driver’s Seat For US Relative Performance
In this post, we highlight the interaction of US outperformance versus the rest of the world this year and US Technology relative to Ex-US Technology.
First, the relative performance of the US equity market versus the rest of the world has been highly correlated with the relative performance of US Technology stocks relative to Ex-US Technology stocks.
Second, the outperformance of US Technology, and by extension the major US indices versus their non-US counterparts, looks likely to continue based on relative earnings estimate revisions patterns.