Bank Stocks Are Getting Crushed. Utilities Are Too. That's Not Supposed Happen. | Utilities Message Board Posts

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Msg  1527 of 1563  at  8/31/2020 7:03:55 PM  by

jerrykrause


Bank Stocks Are Getting Crushed. Utilities Are Too. That's Not Supposed Happen.

 

Bank Stocks Are Getting Crushed. Utilities Are Too. That's Not Supposed Happen.

 

Utilities and bank stocks are telling conflicting tales about the outlook for the U.S. economic recovery. And the accuracy of each sector's pricing could be determined by what happens in Washington in coming weeks.

Both utility and financial stocks have underperformed the S&P 500 this year. Utilities are down nearly 9% and banks are down 18%, compared with the large-cap index's 8.5% advance.

That isn't the way things normally work, as Morgan Stanley points out in a Monday note.

Economic environments in which banks underperform by a wide margin—the way they have this year—are usually good for utilities' stocks. The utilities sector's implicit government backing and 3.5% dividend yield provide safe revenue and income when slow economic growth keeps interest rates low.

And interest rates are low. Treasury yields have tumbled this year as the pandemic caused millions of job losses, brought travel to a halt, and prompted the Federal Reserve to cut short-term interest rates to zero. The 10-year yield is trading around 0.7% and the 30-year yield is around 1.5%, down from 1.9% and 2.3% at the beginning of the year.

Utilities have underperformed the broader market anyway, a trend that has continued over the past five weeks. That can be partly attributed to an increasingly popular view among Wall Street and investors that the worst is over for the pandemic-related economic slowdown. Stocks have risen to records in recent weeks, while the performance of safer securities such as long-term Treasuries have lagged behind. Utilities rose on Monday, with the Utilities Select Sector SPDR (XLU) up 0.2% while 30-year bond yields fell five hundredths of a percentage point.

While worries about loan losses and other economic consequences of the pandemic have been weighing down bank stocks, persistently low U.S. interest rates haven't helped bank share valuations, either.

Shareholders often use the gap between short-term and long-term Treasury yields to gauge the outlook for banks' interest income. The gap between short-term Treasury yields and long-term Treasury yields actually inverted back in February, when the pandemic first hit and investors piled into the safety of longer-term Treasuries.

The gap between short-term and long-term yields widened last week, a move that coincided with bank stocks' outperformance. But it isn't clear whether that trend will continue. It will depend on whether the U.S. economy is in the early stages of a recovery or going to slow again.

Morgan Stanley bank strategists are forecasting a stimulus-driven rebound in economic growth, which would help bank stocks and put more pressure on utilities. They recommended buying bank stocks. The Financial Select Sector SPDR Fund (XLF) was down 0.7% on Monday.

"From our vantage point, the call on [long-term] rates moving higher is just one of timing," they wrote in a note on Monday.

There are a couple of risks to their thesis, however. First is if Congress doesn't pass another pandemic-relief stimulus bill in September. That could hamper the economic recovery and weigh down bank stocks in turn.

"While most market participants believe Congress will pass this bill, the delay has raised some questions about the sustainability of the recovery," the strategists wrote.

The second is if the Fed moves to keep long-term Treasury yields low. The central bank has kept the door open for a policy used in Japan called "yield curve control," wherein the Fed would buy longer-term Treasuries to move long-term benchmark yields to a targeted level.

Lower long-term benchmark Treasury yields support utilities' stock prices by making utility dividends look attractive compared with the fixed-income market. But it isn't likely that the Fed will make such a move soon, going by Fed Vice Chair Richard Clarida's Monday speech to the Peterson Institute for International Economics.

"As for targeting the yield curve, our general view is that…the potential benefits from such an approach may be modest," he said. "As noted in the minutes from our previous meeting…most of my colleagues judged that yield caps and targets were not warranted in the current environment but should remain an option that the committee could reassess in the future if circumstances changed markedly."

 


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