MSCI World Banks Index shows that the global turning point is nigh
JOHANNESBURG - Global bank shares as measured by the MSCI World Banks Index in terms of US dollars are down by 30 percent since the end of last year and the sector’s underperformance is severe compared to developed market equities as measured by the MSCI World Index’s return of 5percent over the same period.
The bear market in banking stocks may have run the course though.
My analysis indicates that the MSCI World Banks Index in terms of US dollars is mainly influenced by the tightening of lending standards of US banks in their lending to large and medium-sized firms.
The Federal Reserve generally conducts the Senior Loan Officer Opinion Survey on Bank Lending Practices on a quarterly basis.
Historically bank shares fell when the net percentage of banks tightening lending standards increases and, vice versa, rose when lending standards starts to ease or taper off. Evidence suggests that the tightening cycle has peaked and that the banking shares have bottomed.
The net percentage of US banks tightening their lending standards for large and middle-market firms reached a level of more than 50 percent on just six occasions over the past 30 years. All of them happened during major global crises - 1990 when Iraq invaded Kuwait following rate hikes in the US the prior year; the Dotcom collapse, 911 and the Enron scandal just after the turn of the century; the Global Financial Crisis in 2008/09, and now with the outbreak of the Coronavirus.
Other regional crises such as the Asian and Russian debt crises in the latter half of the 1990s, the debt crisis in Europe in 2011/13 and the onset of Brexit in 2016, led to a fewer number of banks tightening their lending standards.
The latest survey in August indicated that more than 71percent of US banks tightened their lending standards in the second quarter compared to a high of 84percent during the Global Financial Crisis.
It is important to note that the tightening of lending standards coincided or was led by spikes in the CBOE Volatility Index (VIX) a quarter in advance. (Please note that the highest month-end VIX value was used for a specific quarter.) At this stage VIX has halved from the first quarter this year where March registered the highest month-end value. To me it points to a drop in the percentage of banks tightening lending standards in the fourth quarter.
What it means is that there is a more than even chance that an increasing number of US banks have probably already put a lid on lending standards - yes, the tightening cycle is over. In my opinion the massive rebound of more than 6percent in US retail sales over the past three months compared to the same period last year is testimony of the banks opening their purses and are back in business again. The same relationship between retail sales and the tightening cycle over the past 30 years is about to repeat itself.
My analysis indicates that US retail sales will remain strong through December this year as the net percentage of US banks tightening their lending standards for large and middle-market firms tends to lead the net percentage of US banks tightening standards on consumer loans and credit cards by a quarter.
Yes, I know there are many imponderables, such as the coronavirus seemingly out of control in the US, the upcoming US presidential election and the apparent second wave of the virus in Europe that may all cause further spikes in volatility in stock prices.
Such elevated volatilities created by crisis upon crisis may cause the US banks to err on the cautious side and keep on tightening their lending standards to business and consumers. The flip side of the coin is how US banks will be impacted upon by the much awaited massive stimulus that will be announced before or after the presidential election.
The bulls and the bears have compelling arguments defending their views in regard to volatility. But perhaps there is a clue in the historical distribution of volatility in the fourth quarter over the past 30 years using month-end values for VIX.
In 16 (53percent) of the 30 years, October had the highest volatility, while November and December had the highest volatility in seven of the 30 years respectively. 50 percent of the time or in 15 years, a month in the fourth quarter ended in an above-average VIX of 20 or more. Of that, 60percent occurred in October, 27percent in November and only 13percent in December.
In my opinion, there is a high probability that the volatility we are now experiencing in October may turn out to be the highest in the current quarter.
Surely, South African banks face a different trajectory given the country’s economic crisis? South African banks had outperformed the MSCI World Banks Index by more than 53percent from the end of 2008 until the end of the first quarter of 2018 in terms of US dollars. Thereafter, the rot that set in due to South Africa’s economic woes, amplified by rolling blackouts by Eskom, saw the JSE Banks Index plunge by about 41percent relative to the MSCI World Banks Index in terms of the same currency and 24percent since the end of December last year.
As things stand, I am of the opinion that the banking shares have bottomed or the turning point is nigh. Yes, even South African banking stocks will share in the positive sentiment despite the current economic crisis in the country and the daunting challenges it faces.
The growth prospects of global bank shares are limited though, as apart from cyclical fluctuations, the MSCI World Banks Index in terms of US dollars offered zero capital growth over the past 20 years plus. Yes, the global banks sector is no more than a medium-term cycle play.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.