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Global Interest Rates Fall: Banks Aren't Happy

Daniel Laboe

The 10 year US Treasury note just slid to its lowest level since September of 2017 and it continues to fall. Interest rate benchmarks around the world have seen a decline over the last six months and this decline is accelerating.

The uncertainty with the US-China trade dispute and its recent escalation, combined with a global economic slowdown has investors evacuating riskier securities. Investors are pulling money out of stocks and putting them into safe havens like fixed income, rallying bond prices but breaking yields. This process is called flight-to-quality, occurring in the face of uncertain economic and financial conditions.

The US 10 Yr note yield has fallen more than 25% over the past 6-months and down 12% over just the last month. The S&P 500 has taken a 5.7% dip since the beginning of May as investors pull funds on the increasingly uncertain trade war and global manufacturing concerns.

Latest Trade Development

Both Washington and Beijing are playing hardball as they see whose economy outlasts the other. In the most recent development, China announced the possibility of cutting its US exports of rare-earth metals. China has produced about 90% of the world’s rare-earth metals over the last decade, according to the WSJ, and these metals are crucial for electronic devices and military equipment. This could be bad news for tech companies like Apple AAPL, Microsoft MSFT, Intel INTC, as well as other semiconductor firms that rely on these metals.

Bank Stocks and Decreasing Interest Rates

It should come as no surprise that low interest rates are bad news for banks. A considerable portion of traditional banks are losing margin as interest rates continue to drop. As you can see below, since the beginning of the month, bank stocks like JP Morgan JPM, Goldman Sachs GS, Bank of America BAC, and Citigroup C all far underperformed the S&P 500 (red).

 

Over 50% of JPM’s revenue, 52% of Bank of America’s revenue, and 64% of Citigroup’s top line are all derived from interest income. Meaning that as borrowing and lending margins continue to shrink so will the amount of money these banks are able to squeeze out of interest.

Banks tend to have relatively high betas (>1), implying that a downward move in equities would result in a larger breakdown for bank stocks. Stay away from these investments if you believe that our decade long bull market is coming to an end.

Consumer Confidence

Consumer confidence level just hit a six-month high for May, with the labor market flourishing and consumer spending remaining strong. The trade war and global economic slowdowns haven’t seemed to dampen consumers’ spirit. Below is a 25-year chart of US consumer confidence, and as you can see, things always look brightest before the storm.

 

We are reaching levels comparable to the dotcom bubble in the early 2000s before the colossal market sell-off. I’m not implying this chart is indicative of anything beyond an interesting depiction of how wrong consumer confidence has been in the past. Look for a downtrend in this figure before becoming concerned about your equity positions.

Take Away

Interest rates continue to fall as investors liquidate more and more equity positions to put their funds in safe havens like US Treasuries. This is bad news for banks, especially if it is combined with an economic slowdown. Consumer confidence is up in May, but as history has shown, people are the most optimistic before an economic downturn. Keep an eye on any new developments in the US-China trade dispute, as well as any direction that the Federal Reserve may give in their two-day meeting in mid-June. Nonfarm payroll results will be released next Friday, and can also give you an idea of what course the Fed may take with interest rates moving forward.

 

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JPMorgan Chase & Co. (JPM) : Free Stock Analysis Report
 
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