Banks are back

Central banks are expected to spend 2021 enforcing their ultra-easy monetary policies, despite the expected pick-up in economic activity around the globe, away from last year’s coronavirus-inflicted recession. Governments worldwide are also expected to sustain their loose fiscal policy, with the scope of safeguarding businesses, and by extension jobs, which continue to be affected by restrictions in people’s movement, especially in the services sector.

The combined effect is expected to be positive for banks, who should be benefitting from lower expected credit losses than originally anticipated, backed by the promise of a return to a normality provided by the Covid-19 vaccine rollout during the first half of the year. Trading profits are expected to perform after a bumper year. This indeed could lead to earnings surprises once the new reporting season begins this week.

The market has anticipated this to some extent, with both bank stocks and bonds outperforming the general market over the past couple of months, albeit the sector was one of the laggards throughout 2020.

U.S. banks have been particularly buoyant since the start of the year, aided by a surge in federal spending. The pace of the current momentum hinges on the success of President-elect Joe Biden’s agenda, the scale and execution of the Federal Reserve monetary policy and how quickly Covid-19 is brought to heel.

Investors have been optimistic about economic growth, with the benchmark 10 year treasury yields increasing above 1 percent last week, with banks enjoying a bump in interest rates as they increase lending, deal-making and trading. Last month’s reintroduction of bank stock buybacks and Biden’s selection of Janet Yellen as Treasury Secretary in November also helped, as too the expected increase in infrastructure spending.

This Friday, JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. release earnings, setting the tone for the next few weeks. Stocks have performed since the Fed released its special crisis stress test results in December, which revealed that bank returns should recoup nearly three-quarters of 2020’s decline during the next two years.

Last week, U.S. Banks rose after a number of fresh buy ratings from analysts on bets more government spending was likely in the wake of Democrats taking control of Congress. Across the pond, European banks have been enjoying a similar run, albeit more contained due to the sticky growth problem leading to negative real rates, which is effectively a tax on banks.

Banks worldwide have re-aligned their strategy to focus on non-interest income, therefore we expect these divisions to perform and compensate losses incurred in the credit divisions. Undoubtedly, the investment banking and capital markets divisions of financial institutions worldwide will record strong results, as 2020 was a record year for capital raising due to the imminent liquidity needs by businesses.

Wealth management divisions are also expected to have contributed positively, after indices reached record levels by the end of the year, and the total volume of market participation was remarkable in a very volatile year. This is especially true as large retail flows, nicknamed “robin hood investors” were seen in markets, where professional investors alone no longer dominate market sentiment.

Traditional banks have been facing a generational fight for survival, as they cut fat from their operations using technological offerings to make good for the lower interest generating income. They face stiff competition from leaner, more agile fin-tech firms that are evolving at a rapid pace, and winning market share in an already competitive marketplace. The positive aspect emerging from the pandemic is that it has only forced this process to become quicker as many branches were closed and service offerings forced remotely.

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