This commentary originally appeared on Real Money Pro at 8:20 a.m. ET on Monday, April 4. Click here to learn about this dynamic market information service for active traders.
I recently withdrew all nine bank stocks from my "Best Long Ideas" list and sold off all 13 of my bank longs in the face of a deteriorating outlook for the industry's profits. And over the weekend, I reviewed my earnings projections for the sector and reduced my profit forecasts by about 5% for both this year and next.
I'm now well-below consensus estimates, which have been slow to respond to adverse economic and market conditions. While the consensus has so far been fairly forgiving and the banking sector has largely maintained recent share-price gains, I believe a more challenging period lies ahead for financial firms during the balance of 2016.
In my view, banks' reduced earnings outlook will likely limit the sector's appreciation going forward. My profits downgrade is pretty straightforward and based on the following factors:
- Assuming oil settles in a $30- to $35-a-barrel price range, banks' reserves against energy portfolios will likely rise by about 10% this year. (Personally, I believe oil recently peaked at about $40 a barrel.)
- "Lower-for-longer" interest rates and a bearish flattening of the yield curve mean that banks' net interest margins will barely improve in 2016-17. I've cut my projections for net-interest-margin improvement over the next two years in half, to about seven basis points from a previous 15-point estimate.
- The outlook for capital-market activity has markedly deteriorated. For example, Credit Suisse (CS) recently referenced a 40% year-to-date reduction in volumes.
- The prospects for banks' money-management businesses (which have become an important industry contributor) have grown more problematic. Competition is leading to reduced pricing power and increased profit risks.
- I expect cost savings and layoffs to materially determine banks' abilities to improve their near-term profits. I predict such announcements will coincide with the upcoming earnings-reporting season.
- Global economic growth seems to be moderating, while global trade appears likely to shrink.
- A resumption of widening credit spreads (especially in commercial real estate) looks probable. So do rising auto-loan delinquencies.
- I foresee additional upsetting geopolitical events, as well as a more hostile political environment and a more expensive and burdensome regulatory atmosphere.
- Many are ignoring the steady erosion in European bank-stock prices (check out Deutsche Bank's (DB) three-month chart). But I'm not.
The bottom line: While I like bank stocks for the Intermediate term and over the next few years, I believe the best buying opportunities might come at lower levels than what the sector is trading at today.