While the country sorts through the implications of the historic vote earlier this week, and with the caveat that things can still change and could remain in dispute for quite some time, my big picture takeaway is that the apparent outcome, as it stands today, is largely positive for the bank sector.
1. Divided government likely takes a few issues of material concern off the table.
Perhaps most notably, the prospect of divided government – with a Democrat in the White House and control of Congress remaining split between the two parties — likely eliminates a couple of perceived overhangs on the sector.
- First, higher corporate tax rates, which looked to be a foregone conclusion in the “Blue Wave” scenario, are now probably unlikely to materialize, or at the very least, are much less likely to occur, minimizing the possibility of a strong EPS headwind for next year and beyond.
- Second, any push to “re-regulate” the sector following the pendulum shift toward deregulation over the past several years is now likely to be more incremental than monumental, given the obvious legislative challenges. But even should “re-regulation” occur to some degree, it’s worth noting that bank stock valuations in the years immediately following the Great Recession and Dodd-Frank still improved by about 50%. Moreover, the probability of a very slim Senate majority (for either party) suggests that potential Cabinet appointees from the Senate, including some that are widely viewed as more hostile to banks, are unlikely to come from states with a Governor of the opposing party that can nominate a replacement, since that could potentially upset the balance of power in the Senate.
2. A smaller package is now likely, but we’ll still see stimulus on a massive scale.
While it’s true that we’ll now likely see a much lower level of stimulus than what was discussed in the “Blue Wave” scenario pre-election, we’ll still see a sizeable package, adding further to measures that on the whole are unprecedented in modern times. Indeed, fiscal and monetary stimulus on an aggregate basis, by my estimate, is already to date more than 3x that provided during the Great Recession and its aftermath, which I believe was a much more serious challenge for the bank sector vis a vis the current COVID crisis. Also, less fiscal stimulus is likely to translate to increased monetary stimulus, which is arguably more impactful to the banks anyway and is independent of the political process (and thereby easier to implement as needed). While excess liquidity will undoubtedly drag on margins, it’s certainly worth the cost, at least in my view, if it helps to avert a broader credit-led downturn.
3. While risks admittedly aren’t easily dismissed, the risk/reward dynamic still skews positive.
From my vantage point, and with the caveat that it’s probably still too early to tell for sure, my hunch is that the apparent election outcome doesn’t materially further or diminish the two main fundamental challenges facing the banks at this juncture. So overall, what I saw as a very favorable risk/reward dynamic heading into the election largely remains intact.
- From a credit standpoint, the most significant risk to banks is undoubtedly another national economic shutdown. Has that risk increased or is it now minimized due to the likely “split decision” election result, and what are the resultant implications for stimulus? It’s certainly a debatable point, though it’s unclear ultimately if the odds have shifted decisively in favor of one outcome or the other.
- The retrenchment in market interest rates immediately following the election – coming on the heels of the sharp increase just prior – would seem to reintroduce the possibility of negative interest rates, though this concept is still anathema at the Fed and to many market observers, who note limited benefit in the areas where it’s already been tried. My base case assumption still lies somewhere in the middle – rates are lower for longer (but not negative), which, again, in the context of current bank stock valuations, would be a very manageable outcome.
Joe Fenech is the Managing Principal of SMBT Consulting, LLC, which provides consulting services to banks. Mr. Fenech is also the Chief Investment Officer and Managing Member of GenOpp Capital Management LLC, a regulated investment adviser in the State of Indiana. The article represents the views and belief of Mr. Fenech and does not purport to be complete. The information in this article is provided to you as of the dates indicated and the data and facts presented herein may change. You should not rely on this article as the basis upon which to make an investment decision; this article is not intended to provide, and should not be relied upon for, tax, legal, accounting or investment advice.
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