(Bloomberg Opinion) -- If the biggest U.S. bank stocks were junk bonds, they’d be incredibly enticing for investors on a purely relative basis.
Wells Fargo Securities LLC analyst Mike Mayo pointed out on Bloomberg Surveillance last week that these equities will deliver yields of more than 8% when factoring in the enhanced dividends and share buybacks made possible after the banks cleared Federal Reserve stress tests. Indeed, after the stock market closed on Monday, the nation’s six largest lenders signaled that their dividend payouts would rise, on average, by almost half. Morgan Stanley led the pack by doubling its quarterly payout and announcing as much as $12 billion in share buybacks.
The expected shareholder payouts on these stocks equate to a rate of return that’s more than 4 percentage points higher than average yields on the riskiest corporate debt and about 7 percentage points above benchmark Treasury rates. That is big money in an ultra-low-yield world. As Mayo pointed out, “That gap is one of the widest in history.”
And yet bank stocks have barely responded to this seeming bonanza. On Friday, the day after stress test results came out, the S&P 500 Financials subindex rose just 1.25%. Even shares of Morgan Stanley didn’t take off, rising about 1.9% in after-market trading following the firm’s payout announcement. (They were up about 3% in pre-market trading on Tuesday.)
The key here is these banks stocks are, in fact, stocks, not bonds. There’s a reason they haven’t rallied tremendously in the face of a new wave of cash flooding into shareholders’ hands. A lot of this is already priced in, with a 34% gain for financials in the first five months of the year.
Additionally, the scale of the payouts aren’t all that unusual. In 2019, for example, shareholder payouts as a proportion of the biggest U.S. banks’ combined market capitalization totaled 11.4%, according to estimates by Bloomberg Intelligence. While this year’s expectation for a 9.1% yield is higher than the proportion of cash distributions from 2015 to 2018, some of the cash is simply delayed from 2020’s relatively paltry 4.1% yield, when the coronavirus pandemic prompted regulators to restrict bank payouts.
Equities are pricing in future growth, not future promises of cash returns. The question is whether banks can increase these payouts in the quarters to come or even maintain them with some certainty. And the answer to this remains unclear, especially as more investors start to consider a world that’s past peak growth, where the yield curve is flattening, consumer loan growth remains tepid for a more extended period and trading volumes decline amid low volatility.
In fact, as Bloomberg Intelligence’s Alison Williams pointed out, the biggest news from bank executive presentations this month was not that trading revenues would decline. That was expected. Rather, it was the tepid outlook for consumer loan growth at places like Citigroup Inc. and JPMorgan Chase & Co. that was more noteworthy. Consumers have a lot of money saved in their checking accounts, and they apparently have less need to borrow from banks.
“When you look at banks in the second half, it’ll be very hard to surprise to the upside,” Williams said in a phone interview.
This is not an argument against bank stocks, per se. In fact, even if shareholder payouts return to last year’s relatively meager 4.1%, they’d still be higher than current junk-bond yields, depending on an investor’s entry point. Stocks are increasingly preferable to bonds in many cases purely based on their relatively hefty cash payouts. This is especially true for investors who believe in the reflation narrative, that economic growth will rocket ahead as rates remain low.
That said, the lackluster advance in bank stocks shows why such simple yield comparisons aren’t enough to make bank stocks shine. They need more than just cash. They need to reflect faster economic and consumer growth than is being priced in now and a steeper yield curve than perhaps Fed communication will allow. And that’s a much higher bar to clear.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Lisa Abramowicz is a co-host of "Bloomberg Surveillance" on Bloomberg TV.
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