Banking-Sector Momentum Builds
Faraday Research | Dec 08, 2016 02:43PM ET
Since Brexit, UK banks have carved out a well-established and multi-legged up trend. With the sector rocketing higher this week, let’s take a look to see if this rally is set to roll on.
First, let's dispel the notion that what we are seeing is simply a ‘Brexit bounce’. The FTSE 350 Bank Index recouped its Brexit losses in just over a month and has subsequently rallied more than 20% beyond its pre-Brexit levels.
There are clearly other factors in play.
h3 Rising Rates = Rising Profit Margins/h3The first major driver behind the rally is increased expectation of rising rates -- albeit primarily in the US. Over this period, US employment has steadily risen and inflation pressures have built. Accordingly, we are fast approaching the end of the current super-dovish Fed era.
With higher interest rates supportive of banking profit margins, entering a new interest-rate cycle is of course welcomed by the sector.
Last month the sector again legged higher following Trump’s election win. The president-elect’s plans to boost US fiscal spending is widely expected to force the Fed to raise rates sooner than later. Some investors believe Trump will also cut banking-sector ‘red tape’ but in truth, the jury remains firmly out on that.
h3 Brexit Armageddon Fails To Materialize/h3Elsewhere, armageddon-like Brexit forecasts that have failed to materialize are also fueling the rally.
Strong UK Q3 business investment and consumer spending have seen UK GDP growth beat forecasts. As investors become more comfortable with the idea that all is not doomed, investment has slowly starting rotating back into the highly cyclical financial sector.
Getting back to the here-and-now, this week has seen the sector again kick back into gear. After rallying sharply higher Tuesday and Wednesday, the FTSE 350 Banking Sector Index is now at levels not seen since August 2015.
Despite momentum steadily building across the banking sector over the past five months, this latest leg higher needs to be heeded with caution.
h3 What Italian Worries?/h3Into last Sunday’s Italian constitutional vote, investor fears that a ‘no’ vote would severely hamper the ability for Monte dei Paschi (OTC:BMDPY) to receive a bailout played heavily on the sector. Questionably, UK banks rallied sharply this week despite Italy’s constitutional vote failing and prime minister Matteo Renzi standing down.
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Of course the bullish backdrop of rising rates and an improving UK economy still stand. However, with Italian bank capitalization levels still looming and the sector looking over-stretched to the upside, we are heeding caution in the near term.
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