Bank Stocks Signal Credit Crunch To Come, Despite Goldman/Wells Story

In recent days, broad US equity markets have started to sell-off, a move that many feel could lead to a retest of lows and push the S&P 500 index towards the 2200 level. Volatility is rising and save haven assets like Treasuries are well bid.

Volatility rising again

While the Nasdaq NDAQ 100 has recently been in positive territory for the year, and tech has rightly attracted a lot of attention given the way the coronavirus has highlighted the importance of the digital economy, the sector to watch is financials.

In Europe, notable banks like Societe Generale now trades at the lowest level since 1991, and in the US a key banks ETF, XLF is already closing in on  lows, Wells Fargo WFC has this week traded below its March lows and JPMorgan JPM , perhaps the key financial lynchpin of the economy is uncomfortably close to its recent lows. Wells is up today on a market story regarding a union with Goldman Sachs, but the longer term pressure on banks is very clear.

Negative rates?

This all points to the next phase of the coronavirus crisis being a credit crunch – unemployment figures, small and medium sized business survey’s and the decimation of service sectors like restaurants, all tell this unfortunate story. As the Federal Reserve Chairman has effectively admitted, the Fed itself – and the ECB in Europe – cannot forestall this credit crunch.

Risk of a recession has lead some to talk of negative interest rates – the aim of which is to force people to deploy cash as spending or investment. The US should be very careful here. The experiences in Japan and Europe with negative interest rates is not positive.

European banks crushed

Since the introduction of negative rates in the euro-zone, bank stocks have been crushed – Deutsche Bank trades at a fraction of its pre financial crisis value. There is an ongoing debate between the European banks and the ECB as to the merits of negative rates with the ECB holding that it has saved the banks from higher bad loan provisions.

One difference between European/Japanese and Americans banks s that the balance sheets of the European banks never really recovered from the global financial crisis and they were more heavily regulated than their American peers.

America becomes Japan?

With interest rate markets now beginning to price in negative interest rates in the US from next January, the case of Europe and Japan bears watching. For investors, the risk is that the ‘America becomes Japan’ as far as its banks are concerned. For households, the concept of negative rates would likely be confusing, and as we know from experience, consumers do not always behave in the way theoretical economists expect and it might well be that negative interest rates cause more panic than promote growth.

Against this backdrop, several indicators bear watching by investors. Credit spreads – especially risky credit spreads like CCC bonds which are beyond the realm of fed purchases, the price of REITS and the municipal bond markets will all give signals as to the credit stress ahead.

Banks to lead Tech lower

Lessons from previous credit stresses in the euro-zone suggest that bank debt and equity prices will be the lead indicators for the rest of the equity market. As it stands the gap opening up between Financials and the Nasdaq is too big and suggests that the big tech names are vulnerable should credit stress continue.