US banks outperformed the broad market significantly again in December 2023, for the second consecutive month. But it was just the 5th month of outperformance since the start of the year. Banks also ended the month in the green for the second time in a row after three months in the red.
US banks outperformed the broad market significantly again in December 2023, for the second consecutive month. But it was just the 5th month of outperformance since the start of the year. Banks also ended the month in the green for the second time in a row after three months in the red. Thus, BKX index soared by 13.1% MoM in December vs +4.4% MoM of SPX index. Absolute December 2023 performance was +1.7 std from the mean monthly performance, and it was in the top 5% of absolute monthly performance in the index history. Relative December 2023 performance was +8.3% MoM. It is +1.7 std from the mean monthly performance, and it is in the top 4% of relative performance vs SPX index since the inception of BKX index. But given quite weak performance in the first half of the year, relative performance in 2023 was close to multi-decade lows – BKX index underperformed SPX index by more than 23% yoy vs -25.7% yoy in 2020. Western Alliance, Comerica and Zions Bancorp were among the best performers in December, having increased by more than 23% on MoM basis, driven by continuing decline of the rate expectations. Volatility remained quite high so far but it decreased slightly in December due to significant growth of US banks. Thus, difference of monthly price changes between the best and the worst performers of our sample of banks was 22.1% in December vs 25.4% in November, the highest figure over the last 5 months. So, the average difference for 2023 was 27.4% vs the average for 2022 year of 19.9%. However, correlation between price changes ytd and EPS FY24E changes ytd among BKX index members decreased notably in December, albeit remaining quite high, equal to 72% as of the end of the year.
US banks continue trading with a significant discount both to historical averages and to S&P 500 Index, given still quite weak performance of US financial institutions on absolute and relative basis in two recent years, even despite noticeable decline of profit and revenue estimates. However, the discount continued narrowing in December. Thus, median P/E 23E of our group of banks increased from 8.6x (as of November 30, 2023) to 9.8x (as of December 29). In turn, median P/E 24E went up from 9.1x to 10.3x for the same period of time. Nonetheless, banks are still trading at -1.4/-1.4 std on P/E CY and at -0.7/-0.5 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages (as of December 29, 2023). As for relative to S&P 500, banks are currently trading at -1.6 std and -1.2 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. Median P/B of our group of banks increased from 1.01x (as of November 30, 2023) to 1.24x (as of December 29), already back to a historical average. On P/B, banks are trading with a tiny premium, +0.1 std from the sample mean (2010-current moment) vs SPX with +1.6 std, despite current ROE premium to historical averages are roughly the same for both BKX and SPX indexes. As for individual names, multipliers are still quite different, and dispersion across banks has increased noticeably ytd, which is not surprising given the regional banking crisis impact. However, dispersion decreased somewhat in recent months. Nonetheless, WAL’s P/E estimates for the nearest years are around 7-8x while NTRS’s ratios are 12-14x.
US macro indicators revealed in December were slightly better than expected, while GDP growth forecasts continued going up, increasing probability of ‘soft landing’ further. So, despite noticeable deceleration of economic activity after quite strong 3Q23, US GDP growth will remain positive in the coming quarters. According both to the Fed’s and the market projections, the ‘soft landing’ remains the baseline scenario, at least at the moment, even despite a number of indicators still pointing to a recession, the probability of which is estimated at around 50%. Moreover, the dovish Fed’s meeting in November and December accompanied by lower inflation data allows us to hope that rates will not be so high for longer as it has been implied more recently. So, rate expectations for the nearest years moved significantly down in 4Q23, currently implying 5 rate cuts in 2024 with the first one as early as in March. It will ease the funding pressure on NII/NIM noticeably as well as it will also lower unrealized losses on HTM/AFS securities. Nonetheless, it is too early to say that the US economy has already been completely out of the woods and that inflation battle has already over. At least, December CPI was higher than expected while the labor market continued cooling gradually with total employment tumbled by 683K in December vs +586k in November. In turn, consumer spending, which was the key reason of the US economy resilience in 2023, still remains solid – November retail sales exceeded estimates notably – while consumer sentiment soared in December, driven by lower petrol prices.
4Q23 earnings season should answer the question how justified was the rally in banks during the last 2 months of 2023. It will be kicked off by the reports largest US banks – JPM, BAC, C, WFC – on January 12, 2023. After that, all members of BKX index will reveal quarterly earnings for the next two weeks. Despite the recent rally, we don’t expect that 4Q23 results will be markedly different from 3Q23 earnings, even taking into account significant decline of both rates and rate expectations in the last quarter of 2023. As in 3Q23, we expect that 4Q23 earnings season should confirm the idea that fundamentals deterioration of US banks is gradually bottoming out, and reduce further uncertainty over future earnings. So, FY24 outlooks will be much more important than 4Q23 figures. Moreover, despite fundamentals still remain resilient, it doesn’t mean that the worst is over, especially in case of weaker than expected economic growth. At least, both revenue and profit estimates continued going down in 4Q23, although the GDP growth was higher than expected. So, despite the dovish Fed meetings in November and December as well as lower than expected CPI/PPI figures and higher probability of ‘soft landing’, NIM will keep going down in the nearest future, loan growth will inevitably decelerate further while credit quality will go on deteriorating. Thus, it is expected that median decline of NII of our banks sample will be around 2% qoq, or -8% yoy, in 4Q23. So, NIM will remain the key driver of decline while earning assets turn to growth in 4Q23. In turn, TA of US banks increased by 1.3% MoM in December while total loans went up by 2.3% yoy as of the end of the year, albeit continuing to slow down. Deposits also resumed growth recently, +0.3% qoq or +0.8% MoM as of the end of December, while total liabilities increased by 1.4% MoM, or +1.7% yoy. Credit quality will remain strong, but it will be closely monitored by investors given a number areas of concern – office CRE, lower-end consumers etc. Thus, allowance for loans and lease of domestically charted US banks increased by 1.4% MoM in December, notably outpacing growth of the total loans. So, ROE will remain double-digit in 4Q23, but it is more important whether it will remain so high in 2024.
Mid-term earnings visibility of US banks has improved recently but it is still bumpy road ahead, at least in 1H24. Nonetheless, current fundamentals do not look any weak so far even after some deterioration in recent quarters, remaining even slightly better than the averages for the previous cycle. Moreover, we expect that estimates will turn more positive in the coming months. On the other hand, valuations became less compelling after the recent strong rally, albeit still remained low. So, we still remain cautiously optimistic on the sector but risk-reward ratio has already deteriorated markedly.