(MENAFN- Khaleej Times) The plunge in US Treasury bond yields has taken a huge toll on US money center and regional bank stocks even as some insurer shares have been eviscerated by 20 per cent due to estimated losses related to Hurricanes Harvey and Irma. The surge in US bank shares after Donald Trump's election was the anchor of the stock market rally that literally began on Election Day.
Wall Street embraced a consensus view that Trump's tax reform, fiscal stimulus and laissez faire stance on financial regulation would accelerate US economic growth and lead to a steeper US interest rate curve. This scenario was vapourised by Trump's dismal track record as the forty fifth President of the United States. In April, bank shares began to lag the S & P500 index as doubts about the "Trump Trade" swept Wall Street.
Last week, the bank sector was crushed as the yield curve flattened, which means lower interest rate margins for banks. The hurricane Harvey/Irma shocks on the Texas, Louisiana, Florida and Georgia coastal economies suggests US economic growth and loan demand will decelerate. This means no more Fed rate hikes in 2017 and "lower for longer" interest rates.
Banks borrow short term and lend longer term, meaning that they make more money when long term rates rise faster than short term rates. This scenario of a steeper US Treasury yield curve implies strong economic growth and rising credit demand. Yet the flattening of the yield curve to pre-election 2016 levels suggests softer economic growth, softer loan demand and no Fed rate hikes. Since S & P Bank exchange traded fund made a death cross last week. This is a chart augury of an imminent trend reversal.
Citigroup is the most globalised of the US money centre banks. Its shares have fallen from 70 to 66 or just below its tangible book value. I find it significant that Citi management outlined 2020 targets in its first Investor Day since the 2008 financial crisis, when the bank almost failed and survived only after an Uncle Sam bailout. Citi management now targets return on assets of 90-120 basis points and $9 in earnings per share by 2020. This EPS target means the bank expects to grow earnings per share by a 17 per cent compound annual growth rate in the next three years. Citi also quantified the source of its earnings growth targets: 50 per cent from share buyback, 40 per cent from growth in business operation, 10 per cent from Fed rate hikes. Note that given the bank's large deferred tax balances, it is a huge beneficiary of tax reform. Citi is also a beneficiary of any rollback of the Dodd Frank post-crisis bank regulation straitjacket.
Citi's crown jewel is its Global Consumer Bank, which has priceless franchises in the US, Mexico and 12 major Asian countries. It is no coincidence that management expects the Global Consumer Bank to be the growth engine of the bank's planned profit and cost control initiatives.
The other ballast for Citigroup shares in 2017, 2018 and 2019 will be $19-$20 billion in share buybacks each year, given the excess capital that the bank plans to generate until 2020. So the bullish case to own Citi is nothing less than the prospect of the biggest shareholder capital return in the history of international banking. Of course, Citi has the largest emerging market footprint of any American money centre bank, another source of future growth in consumer/corporate banking, Treasury/Trade solutions and investment banking/capital markets.
None of the above will insulate Citi from the current bearishness in bank shares. It is possible that Citi shares fall to 56-58 in this correction. Yet if CEO Mike Corbat delivers $9 in EPS three years from now, arithmetic alone suggests Citigroup shares will double at current valuation multiples. Fantasy? No, mere extrapolation! Citigroup illustrates Warren Buffett's advice that it is better to trust time in the market than market timing in the investment game. The North Korean crisis and the twin hurricanes make it politically impossible for the Federal Reserve to raise the Fed Funds rate at the September FOMC. The US central bank will wait to estimate the impact of the twin natural disasters on the US economy and also the outcome of the Congressional tax reform debate this fall. In any case, consumer price inflation growth is 1.7 per cent, well below the Fed's two per cent target. So even a December rate hike necessitates an uptick in wage inflation data.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at:
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