How Deflation is Killing Bank Stocks

Wednesday, October 29, 2014 How Deflation is Killing Bank Stocks   by Jamie Dlugosch   Investors in bank stocks are facing serious short-term pressures.   The focus might have been on the stock market testing corrective territory early in the month, but the real story is deflation.   With most everyone in the fixed income market expecting interest rates to increase, the reality is that rates are going lower.   For proof of deflation look no further than the collapse in crude prices.   The combination of weaker-than-expected global demand and production increases in the United States are conspiring against prices.     FURTHER READING   Massive Special Payout on November 3rd   There's a unique oil company drilling into the largest oil reserve in the Western Hemisphere… deep under the Atlantic Ocean. The deposit is so massive -- and the profits are so huge -- that this company rewards investors with special, unannounced dividend payments -- four times a year. And that's on top of the regular quarterly dividends. That's 8 payments, every year, like clockwork.   The next special payments are scheduled to hit shareholder accounts on November 3rd.   Click here for all the details.     Interestingly when oil prices are on the upswing and inflation statistics are flat, fear mongers cry foul, arguing that higher oil prices are indeed inflationary.   So where are those fear mongers today with oil prices plummeting?   They should be raising the same level of fear about deflation, arguing for global central banks to aggressively print money to prevent prices from falling further.   But fall further they will. Goldman Sachs recently put out a report saying that crude prices could be headed to the $70s or lower.    OPEC is standing idly by, hoping in private that lower prices kills the economics of tracking, and global central banks thus far are taking not nearly enough stimulative action. Thus, there is little resistance to prices falling further.   That's just horrible news for banks in the United States.   Banks and investors in U.S. banks have been waiting patiently for the next phase of the recovery from the financial crisis that supposedly will usher in higher and higher profits.   The key to the investment thesis will be higher rates, not lower rates.   With higher rates, banks have the potential to be far more profitable. The potential of that profit-making ability has resulted in bank stocks appreciating greatly.   Perhaps they have appreciated too much especially if one believes that rates might be going lower before they go higher.   Ultimately, for the higher-rate scenario to play out one must have a really long time horizon.   One group of investors not likely to wait around that long: those participating in exchange-traded funds.   The Financial Select Sector SPDR (NYSE: FSLR) experienced the largest weekly withdrawals since 2009. Investors pulled nearly a billion dollars from the exchange-traded fund as the deflationary story took traction.   Todd Rosenbluth, director of mutual fund and exchange-traded fund research at S&P Capital IQ, thinks investors should be less exposed to the financial sector in general as future prospects do not look promising.   Indeed, short interest in Bank of America (NYSE: BAC) increased by 13.5% from the start of the month to Oct. 15.   Shares of Bank of America had been on an impressive run after the company settled its financial crisis mortgage lending dispute with the Justice Department.   If interest rates stay low for too long, none of that might matter.   The stock has already dropped from its settlement-fueled rush to above $18 per share. At current prices, shares of Bank of America trade for 11 times 2015 estimated earnings.   That seems to be a fair price given the potential deflationary pressures in the market at the moment.   I'd look to own Bank of America at lower prices as the lower rate for longer scenarios further pressures shares.   Jamie Dlugosch Editor Investor Research Institute   To Read More From Investor Research Institute Click Here
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