Numbers on display after the closing bell of the Dow Industrial Average at the New York Stock Exchange on June 14, 2018 in New York. Photo: AFP/ Bryan R. Smith
Numbers on display after the closing bell of the Dow Industrial Average at the New York Stock Exchange on June 14, 2018 in New York. Photo: AFP/ Bryan R. Smith

The powerful stock rallies of recent years suffer from an intriguing weakness: bank stocks aren’t going along for the overall ride.

This year, to date, Japanese banks are down about 13%, while Asian banks generally are down about 7%. Europe’s have fared worst of all – down 17%. America’s are down 5%. On June 26, for example, banks extended losses even as US shares held largely steady. That disconnect is now part of a well-established pattern.

Why? Confusion over negligible interest rates, for one thing. Expectations are that the European Central Bank and the Bank of Japan will begin moving rates away from zero. Only, the likely glacial pace of tightening is robbing European and Japanese yield curves of the steepening needed to boost banks’ profit-and-loss profiles.

Question: Are bull markets truly credible if bank stocks don’t participate?

The party is over

Louis Gave of Gavekal Research is doubtful. “Experience suggests it is unlikely,” he explains. “It’s not that banks must outperform for there to be a bull market. But given the weight of banks in most benchmarks, mathematically it is necessary for banks to hold their own, or close to it, for the broader market to trend higher. So perhaps the fact that banks are down in most markets helps explain why the broader markets are struggling despite very solid earnings.”

One problem concerns liquidity. Bank stocks often play a safe haven role when markets get antsy. For decades, that’s been the refuge of investment banks and brokers looking to hunker down as broader indices stumble.

The dearth of places to hide matters because the ranks of hedge-fund veterans bracing for renewed market chaos is growing.

Take Greg Coffey, who until recently managed Moore Capital Management before starting his own shop. He sees “ghosts of 2000” out there – a reference to the dot-com crash. Meantime, Russell Clark of Horseman Capital Management warns of a 2008 dynamic in market moves, a period characterized by “Lehman shock.”

As Coffey wrote to clients recently: “The last five years of quantitative easing has floated all assets and all strategies. Investors were rewarded for both inactivity and buying the dip in everything. That approach will be challenging this year.”

That’s in part because of the odd under-performance of bank shares.

The macro risk outlook

The list of things that could go wrong in markets is growing by the day. Donald Trump’s trade war is the biggest, though worries about slowing Chinese growth – a risk exacerbated by Trump’s tariffs – are also spooking markets. Clearly, the ongoing bloodbath in Chinese stocks is a cause for concern.

Europe’s crisis, meantime, is kicking up anew. Last month, as Italy’s debt woes shook markets, billionaire George Soros warned of an existential threat to the European Union.

The Federal Reserve’s rate-hike cycle also could exacerbate the liquidity troubles. That has longtime observers like Gave wondering if banks now confront a structurally-flawed business model.

“For the last 10 years, banks have been under attack from many angles,” Gave explains. One challenge: regulatory tightening in response to the collapse of Lehman Brothers, which limits the latitude to leverage up balance sheets and boost returns.

The real wild card 

But, he adds: “Perhaps more worrying, banks’ core businesses are now under attack from new, and usually less regulated, entities. Whether it’s peer-to-peer loans undermining low credit score loans, e-payment platforms undermining the rich transfer fees banks used to charge, or the growth of exchange-traded funds undercutting money management fees, wherever you look, the rapid growth of the broader fintech industry continues to undercut bank margins.”

The crypto-currency boom is another wildcard. Hyperbolic or not, talk of whether banks have a future as blockchain advancements meet the smartphone app economy is no longer taboo.

Any good news here? Well, one can argue that, post-2008, bank balance sheets aren’t massively overextended. It means any return to 2000, 2008 or 2013, when the Fed “taper tantrum” hit markets, isn’t likely to savage banks.

The bad news, though, is that this also could be a canary in the proverbial financial coal mine. Bank stock dynamics hint at changes in the financial landscape, from New York to Tokyo, that we don’t fully understand.

And what panics hedge funds more than market mysteries?