The Rosy Outlook for Financials Is a Bunch of Bull
There is no market sector that has been as embraced as heartily as financials.
* But, the domestic economy is slowing, the Trump regulatory and fiscal policy put may be waning, the yield curve is flattening, interest rates are contained, protectionism is rising around the world and bank valuations are back to pre-crisis levels.
* Sell banks and other financial stocks.
The outlook for financial stocks appears less rosy than the bulls think.
As I've written previously, the judgment day for financials has come and gone. It is now time to act by selling or shorting bank stocks.
Richard Fisher, the former president of the Federal Reserve Bank of Dallas, told me this great quote that his mother once made; it applies to the popular bank sector:
"Skepticism is the chastity of the intellect; do not surrender it lightly."
Group stink has never been more conspicuous than in financial sector stocks -- banks, brokerages and selected financials.
A day does not go by in the business media that a talking head doesn't exclaim his or her adoration for financial stocks. That view is typically underscored by self-confidence and total disdain and lack of respect for the contrary view. But financial stocks, despite their popularity, already are starting to weaken and potentially roll over in the face of growing threats that few are heeding. The weakness recently been most conspicuous in life insurance and brokerages, particularly Goldman Sachs GS; it now may soon be floating into banking stocks.
The bottom line is that everyone's favorite group, the financial sector, may be heading for an extended period of underperformance.
More aggressive traders might consider shorting bank stocks; I plan to today.
My concerns are on several fronts: a weaker U.S. economy, sustained lower interest rates, diluted regulatory reform efforts, the likelihood of poor forward capital markets activity, elevated valuations (back to pre-crisis levels) and disappointing profit growth relative to consensus:
* SLOWING DOMESTIC ECONOMIC GROWTH: Given the 15-month low in the U.S. Citigroup Surprise Index discussed last week, it appears, once again, that consensus domestic economic expectations of a hockey stick of growth are at risk.
As Jim "El Capitan" Cramer wrote yesterday, if one takes out two massively outperforming transportation stocks, the transport index is also screaming out a slow-growth backdrop.
The U.S. economy is weaker than many believe. Forgotten by the bullish cabal is that zero interest rates have pulled forward a great deal of economic growth and a large amount of debt that is growth-deflating has been created over the last eight years.
Retail is undergoing an existential crisis as the channels of distribution change violently, but the problem facing retail likely runs deeper:
Auto sales are peaking as used-car prices drop, a record number of leases expire (creating a bulge in inventories), incentives move to multiyear highs, the inventory-to-sales ratio moves back to 2007 levels and auto paper delinquency rates deteriorate further. Conversations I have had with several large regional auto dealers confirm the view that the industry's activity likely will surprise to the downside over the balance of the year and into 2018.
Housing will also disappoint, reflecting a record rise in affordability as home prices breach above 2007 levels.
* LOWER RATES AND A FLATTENING YIELD CURVE: This morning the 10-year U.S. note yield stands at 2.238% -- at the lower end of the recent range -- and the 2s/10s curve is down to only 94 basis points, a multi-month low. If the 10-year U.S. note yield stays in the recent trading range of 2.20% to 2.60% through 2017, financial intermediaries that have an imbalance of rate-sensitive assets over liabilities -- meaning that they thrive when rates rise -- could be vulnerable both with regard to earnings estimates and in achieving the Street's ambitious share price targets.
* TRUMP'S REFORM INITIATIVES SEEM LIKELY TO BE DELAYED AND DILUTED: Further delays and dilution of the administration's economic policy initiatives could also mean that general expectations of accelerating economic growth and of much higher interest rates are in jeopardy. It seems to me that consensus rate expectations for the third consecutive year will likely be reduced.
As important, regulatory reform is likely also going to be delayed.
* GOLDMAN SACHS' SINKING SHARE PRICE (down $40 from its 12-month high) MAY BE A "TELL" AND PRECURSOR TO LOWER CAPITAL MARKETS ACTIVITY
* VALUATIONS OF BANKS STOCKS HAVE RETURNED TO PRE-GREAT RECESSION LEVELS: Much -- higher interest rates, better profit growth and timely regulatory reform -- must now come to pass for the bank stocks to maintain current valuations.
Bottom Line
With interest rates low, a flattening yield curve, a delay in regulatory reform, weakening capital markets activity and slowing economic growth, there will be no "hockey stick" recovery in bank industry profits to support current valuations, which have increased back up to pre-crisis levels.
