Bank Stocks:
There's More to the Story than Rising Rates

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Tuesday, April 9, 2019

In late March, bank stocks gave up approximately two-thirds of their strong year-to-date gains—falling sharply on concerns about economic and earnings growth. Banks ended the quarter up nearly 12.5% after regaining some lost ground during the last few days of the quarter.*

The primary trigger for the sell-off was the March 20th Federal Open Market Committee (FOMC) announcement that it wasn't raising rates and no longer expected to raise rates twice this year, as previously suggested. (As recently as January the Fed had expected two more 25 basis point increases in 2019.) The Fed also announced that its median GDP projection for this year and next had modestly declined to 2%, citing slowing retail sales, business investment, and job growth. It expects unemployment to remain at 4%.

Bank stocks can be more interest-rate sensitive than the market as a whole because banks garner some earnings from the spread between the rates they charge for loans and the rates they pay on deposits. In rising-interest-rate environments, rates on loans generally reset faster than rates on deposits, temporarily widening this spread.

We think the market overreacted. The widening of spreads is a temporary benefit to banks, in our opinion, because deposit rates will eventually catch up.

While changing interest rates can lead to a wiggle in bank earnings, we believe that it's actually changing credit conditions that can make them gyrate—and credit trends remain healthy. With the Fed still forecasting modest GDP growth both this year and next, we foresee little risk of rising default rates.

Why We Own Banks

The Miller/Howard Income-Equity strategies own banks that pay solid dividends, and we expect those dividends to rise. The banks that we invest in generally have balance sheets that the Fed has deemed strong enough to support continued dividend payments, even in a severe economic downturn. They also have earnings growth driven by a combination of loan growth, expense reduction, and share buybacks, as well as attractive valuations at 9 to 12 times forward earnings.

On June 30th, the Fed will announce the results of banks' 2019 stress tests, and whether it has approved each bank's dividend and buyback request. Last year, banks issued press releases the same day, announcing sizable dividend increases as well as buybacks with dollar values more than twice as large as the dividends.

We expect dividend increases again this year driven by earnings growth. But further support could be provided by banks' ability to reallocate available cash to shareholders from buybacks to dividends. Also, by reducing the number of shares outstanding since last June, buybacks can increase both earnings per share and dividends per share, even if total earnings and dividends don't rise.

We expect that first-quarter earnings reports will provide us with more information about trends in loan quality and earnings. We seek bank stocks that best match the changing economic landscape while providing dividends, prospects for dividend growth, financial strength, and consistent earnings growth.

*Based on the S&P Banks Select Industry Index total returns from December 31, 2018 to March 31, 2019. S&P Select Industry Indexes are designed to measure the performance of narrow GICS® sub-industries. The Index comprises stocks in the S&P Total Market Index that are classified in the GICS asset management & custody banks, diversified banks, regional banks, other diversified financial services, and thrifts & mortgage finance sub-industries.


Gregory Powell, PhD, Deputy Chief Investment Officer, focuses on the firm's Income-Equity portfolios. Greg joined Miller/Howard after a distinguished 19-year career as a portfolio manager and director of research at AllianceBernstein. At AB he managed a team of 12 analysts and a suite of products with $11 billion in AUM, including equity income, long-only value, diversified value, and long/short hedge funds. He also served as head of fundamental value research there, redesigning the analyst role with an emphasis on investment success and training analysts in all aspects of the position. Prior to AB, Greg worked for 12 years at General Motors in Detroit and São Paulo, Brazil. He began his career as a senior economist and became general director of market research and forecasting. Greg holds a BA in Economics/Mathematics from the University of California, Santa Barbara, and a PhD and MA in Economics from Northwestern University.

© 2019 Miller/Howard Investments, Inc.

Investment products: are not FDIC insured - May lose value - Are not bank guaranteed

Opinions and estimates offered constitute Miller/Howard Investments' judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. All investments carry a certain degree of risk, including possible loss of principal. It is important to note that there are risks inherent in any investment and there can be no assurance that any asset class will provide positive performance over any period of time. The material may also contain forward-looking statements that involve risk and uncertainty, and there is no guarantee they will come to pass.

Common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time. Dividend yield is one component of performance and should not be the only consideration for investment.

The information above is from sources deemed to be reliable and is provided strictly for the convenience of our investors and their advisors. These materials are solely informational. Legal, accounting and tax restrictions, transaction costs, and changes to any assumptions may significantly affect the economics of any transaction. The information and analyses contained herein are not intended as tax, legal, or investment advice and may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal, investment, or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability. Any investment returns — past, hypothetical, or otherwise — are not indicative of future performance. Investment Decisions: Do not use this report as the sole basis for investment decisions. Do not select an allocation, investment discipline, or investment manager based on performance alone. Consider, in addition to performance results, other relevant information about each investment manager, as well as matters such as your investment objectives, risk tolerance, and investment time horizon.

Past performance does not guarantee future results.

DISCLOSURE

Investment products: are not FDIC insured - May lose value - Are not bank guaranteed

Opinions and estimates offered constitute Miller/Howard Investments' judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. All investments carry a certain degree of risk, including possible loss of principal. It is important to note that there are risks inherent in any investment and there can be no assurance that any asset class will provide positive performance over any period of time. The material may also contain forward-looking statements that involve risk and uncertainty, and there is no guarantee they will come to pass.

Common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time. Dividend yield is one component of performance and should not be the only consideration for investment.

The information above is from sources deemed to be reliable and is provided strictly for the convenience of our investors and their advisors. These materials are solely informational. Legal, accounting and tax restrictions, transaction costs, and changes to any assumptions may significantly affect the economics of any transaction. The information and analyses contained herein are not intended as tax, legal, or investment advice and may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal, investment, or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability. Any investment returns — past, hypothetical, or otherwise — are not indicative of future performance. Investment Decisions: Do not use this report as the sole basis for investment decisions. Do not select an allocation, investment discipline, or investment manager based on performance alone. Consider, in addition to performance results, other relevant information about each investment manager, as well as matters such as your investment objectives, risk tolerance, and investment time horizon.

Past performance does not guarantee future results.