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Only 10 US stocks really matter

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Good morning. It’s the outlook season for 2022, and today we’re looking at the S & P 500 (depending on a few large companies) and US banks (more complex than they look). Ethan and I will be off tomorrow, but please email us. robert.armstrong@ft.com When ethan.wu@ft.com..

In 2022, pay attention to S & P10.

The air is full of holiday cheers, but sell-side equity strategists aren’t breathing it in. Bank of America at the end of last month is:

“By the end of 2022, we expect the S & P 500 to reach 4,600 (minus 2% from here) .. .. Driving factors for our outlook: rising discount rates, US GDP advantage over China, capital investment gain [and] Delay consumption. “

And Morgan Stanley:

“As we have pointed out for a long time, the inevitable mid-cycle transition when economic growth slows, profit corrections slow down and fiscal conditions become tight is usually a policy adaptation that raises interest rates. It’s a sign of change. [profit/earnings ratios] Below. .. .. As the market P / E returns from the current 22.5 to the more normal 18, headwinds are sufficient to limit the base case forecast of 4,400. If that’s right, the S & P 500 will drop 3% in the next year. “

If large-cap US stocks perform poorly, it’s a big turnaround. They had a great year and shattered the rest of the world:

However, most of the outperformance, especially in the second half of the year, has fallen to S & P’s largest 10 stocks.

The majority of US stocks outperform non-US stocks by 11 percentage points, compared to 28 points on S & P 10. Everything has risen this year, most of which have risen significantly.

Should the highest weight of the S & P 500 make us uneasy? S & P 10’s price-earnings ratio has averaged 34 since September, up significantly from the five-year average of 29. Fiscal and monetary policy tightening and the threat of inflation can reverse its expansion.

But the investor has to own something. In the harsh environment of 2022, you don’t want to own a stake in Tesla. But which global company is better at protecting profits than Google, Amazon, or UnitedHealth? In 2022, the fate of the S & P 500 will depend on the S & P 10. And from a relative point of view, 10 seems to continue to outperform. ((((Ethan Wu).

Prices are rising, so buy a bank — is that so?

The US central bank plans to raise interest rates next year unless something very unexpected happens. So it’s time to buy bank stock, urging Morgan Stanley’s research team. It writes:

“All Morgan Stanley strategists are overweight for banks (except Australia) and financial institutions. It makes sense because banks become a clear alpha generator when interest rates rise. In fact, in the United States, in real terms. Only banks and diverse financial institutions surpassed the S & P 500 when interest rates rose. Our economic team expects punchy inflation to continue until 2023, and strategists said this year. We are looking for higher real interest rates .. Lending is expected to pick up. Consumer loan growth is driven by expectations of continued spending on housing and consumption as savings are depleted. The growth of commercial loans is driven by the need to fund growing inventories. “

The paper here is simple (and MS is not the only bank promoting it). Banks will do well as interest rates rise, and weak lending growth will rebound as the economy recovers, so buy banks. This makes a lot of sense. Bank profits will undoubtedly rise at short-term interest rates.

However, there are two conditions. The relationship between bank stock performance and interest rates is not simple. There is good reason to suspect that commercial lending growth will recover in what MS calls “high inventory restructuring.”

MS provides several charts showing that bank equities tend to rise in inflation, inflation exceptions, federal funds rates and 10-year government bond yields. For example, the federal funds chart is:

Bank stocks were absolutely strong when the Federal Reserve raised interest rates in the last two cycles. But what investors want to know is whether bank stocks have exceeded the index. Therefore, the bank stocks associated with the S & P 500 up to the last rate cycle (Bloomberg data) are:

congestion. Bank stocks were well above the index in the first half of the rate of increase in interest rates (late 2016 to early 2018), but below in the second half. And will the rate increase between 2004-06? Bank stocks fell below the index:

“When interest rates rise, banks become a clear alpha generator” now looks a bit more complicated. Let’s check the correlation of inflation. The MS chart showing absolute banking performance is as follows:

And here is the relative performance of the consumer price index and banks, zooming in over the last decade.

Bank stocks haven’t outperformed since the trend really started to grow at the end of this spring. Inflation expectations charts, rather than actual inflation, show a solid historical correlation, but this year it is not. Bank stocks are not keeping up with the rise in inflation in 2021.

The correlation between the relative performance of banks and the 10-year Treasury yield is well known, but it may not be more directly related to long-term interest rates and economic growth that pushes up bank stocks. However, as discussed here, it is not clear whether the Fed’s own raising of the policy rate would be of great benefit to 10-year bonds. yesterday..

In summary, if the Fed raises interest rates in response to inflation, bank profits will rise.Whether it is a bank stock It’s not so clear to go up.

The idea is that corporate inventories, which have fallen due to supply problems during a pandemic and fierce commodity demand, need to be rebuilt, and companies will borrow more from banks to rebuild them. Now, here is a chart of US corporate inventory and business loans at major US banks.

Corporate inventories in the United States have been steadily increasing for a year and a half and are now Moreover The level before the pandemic. And the balance of commercial loans steadily declined during the inventory build. It is unclear why further inventory increases (to accommodate unusually high product sales during a pandemic) reverse the weak lending trend.

The main reason for the weak lending trend is not the pandemic, but the loss of market share in the bond market and private credit providers and the fact that companies are flooded with cash. Of course, these trends can be reversed — banks will be hurt in a recession.

One good reading

In US politics, always read Thomas Edsall.

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