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Trumponomics: An outstanding opportunity to buy banking stocks

Bank stocks are on a roll. In the first half of last year, tighter regulation and protracted monetary easing kept banking margins under pressure and weighed on the outlook. However, in the space of a few months, the situation has changed completely.

There are signs that the bear market in the banking sector, which had been exacerbated by declining long term rates, with narrower spreads between short and long term rates, is now over.

Anton Schutz, Chief Investment Officer of Mendon Capital Advisors, spoke in an interview on CNBC, the financial news channel, on December 29th last year. He reiterated that, although the recent banking rally has slowed, now is a tremendous opportunity to buy these stocks for the longer term.  

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He says financial institutions will be the first to benefit from the newly inaugurated Trump administration’s prospective corporate tax cuts. With the Federal Reserve likely to raise interest rates three times this year, interest income on bank lending activities will also pick up. Finally, the financial deregulation pledged by Trump is a major tailwind.

With the US administration’s economic policy likely to shift from traditional monetary policy to fiscal stimulus, expectations of a rise in long-term interest rates remain in place. As a result, optimism over the profitability of financial institutions is growing.

 

Buffett opposed Trump, but his profits are up because of him


Source: Shutterstock

Among the major US banks, Schutz particularly recommends buying Bank of America. Its loan book is larger than the other banks, and an increase in interest rates can boost interest revenue by as much as $5.3 billion this year alone. Bank of America shares are up 37% compared with where they were before the election.

Interestingly, Berkshire Hathaway, the investment vehicle led by well-known US investor Warren Buffett, took a position in the bank in 2011. In exchange for $5 billion in cash, Buffett received Bank of America preferred stock, yielding 6% per year, along with the right to buy 700 million ordinary shares at a discounted price of $7.14 (compared with the price at the time of around $12), at any time up to September 2021.

Buying cheap stocks in good companies, holding on patiently over the long term, and waiting for the price to rise, is Buffett's trademark investment style.

At that time, the aftershocks of the financial crisis were still coming through, and nobody would have wanted to invest in Bank of America unless a significant discount was on offer. The shares have moved up sharply over the past 6 months, and the value of Buffett’s preferred stock has increased materially – effectively his investment has tripled to $15 billion. He has certainly lived up to his moniker, “The Sage of Omaha”.

Buffett will have even more to cheer about if the policies of the new administration continue to underpin the rally in banking stocks. Buffett is a liberal at heart. He was strongly opposed to Trump’s candidacy, but he is also very philosophical and broad-minded. He has ended up as a major beneficiary of the policies of the man he opposed, and enhanced his legendary investment prowess in the process.

Amongst other bank stocks, regional banks BNC Bancorp, Synovus Financial and Western Alliance Bancorp are also expected to be winners in a higher interest rate environment.

In addition, Schutz points out that deregulation makes M&A more likely, as these institutions look for more innovative ways to cut costs and boost profit. Either way, there is no doubt that bank stocks remain an attractive way to play the change in the US economic backdrop.

 

The downside of deregulation


Source: Shutterstock

As far as the banks are concerned, there is, nevertheless, a downside to Trump’s proposed relaxation of financial controls. The Wall Street Journal points out that Trump’s deregulation proposals also come with the suggestion of counter measures. So, even if regulation is relaxed, there is a price.

The Republican candidates that Trump is likely to appoint to the Board of Governors of the Federal Reserve are in favour of more stringent capital controls, in other words requirements to hold larger amounts of cash in reserve. Republicans want to avoid 'big government' situations whereby, in a more deregulated environment, the government ends up bailing out banks which fail, however unlikely that may now seem. So for the banks, even if deregulation helps them earn higher profits through taking on more risk, constraints on their ability to put their cash piles to work might reduce the attractions of a looser regulatory environment.

It is not just banks which Trump is turning his attention to. In contrast to the established political system up till now, US industrial policy also looks as if it will be subject to heavier presidential influence (for example, Trump would like companies to reconsider any plans they may have for relocating offices overseas). The indications are that Trump’s politics favor a “command economy” with a “human touch”.

In the meantime, Jamie Dimon CEO of JP Morgan, which is a beneficiary of deregulation, said at the end of last year, "We’re not asking for wholesale throwing out Dodd-Frank.” (Dodd–Frank Wall Street Reform and Consumer Protection Act). He pointed out that in order to comply with this law, the banks have already invested heavily to change their business models, systems and internal cultures.

So they do not want a sudden change or reversal of their strategic direction. It is more a case of adapting the framework. It is also true, in any case, that the law has improved the soundness of management and businesses within the banking sector.

For now, the questions remain. Will US banks’ risk activity pick up again under Trump? Will they argue for a reduction in the burden of capital requirements?

Will former bankers, such as Steve Mnuchin (previously at Goldman Sachs and currently candidate for Treasury Secretary), who now find themselves at the heart of the administration, look to dismantle regulation or will they willingly implement Trump’s command economy policies, in the role of poachers turned gamekeepers? It will be fascinating to see how this apparent conflict resolves itself.

(By ZUU)

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