Bank Stocks Finally Worth Buying to Morgan Stanley Citing Yields

Morgan Stanley is telling clients to boost the proportion of bank shares they own for the first time since the 2008 financial crisis.

Since March, gains in financial companies have been more pronounced when Treasury yields rise and the group tends to advance with an appreciating dollar, according to Adam Parker, chief U.S. equity strategist at Morgan Stanley. After passing the Federal Reserve stress test last month, the industry is poised to see one of the biggest increases in shareholder return via buybacks, he said.

Wall Street firms have yet to regain confidence among investors, who are pulling money out of exchange-traded funds focusing on financial shares more than any other industries. While the group’s weighting in the Standard & Poor’s 500 Index has fallen to 16 percent from 21 percent in 2007, Parker’s team now advises investors to hold one fifth of their money in the group that includes stocks such as Fifth Third Bancorp and CIT Group Inc.

“Historically, banks and diversified financials were the only industries that have a positive and statistically significant relationship to the stronger dollar,” strategists led by Parker wrote in a note Monday. “We like the price action recently and our expectations of reasonable risk-reward related to the slope and level of the curve.

Buybacks, ETFs

The S&P 500 Financials Index is down 1.5 percent this year, compared with a 2 percent gain in the S&P 500. The industry measure rallied 2.2 percent on March 12 after banks including Citigroup Inc. and JPMorgan Chase & Co. won Fed approval to boost buybacks and dividends after earlier passing the central bank’s stress test. The Fed’s review assesses whether big banks have sufficient capital to absorb losses during a sharp and prolonged economic downturn.

Investors have withdrawn $5.2 billion from financial-focused ETFs this year, the most among 12 sectors tracked by Bloomberg.

The trend in bond yields and the currency market are shifting in favor of banks, according to Parker. Low interest rates crimped banks’ profitability last year. Net interest margin, the difference between what a firm pays in deposits and charges for loans, was a record-low 3.1 percent in the third quarter of 2014, according to St. Louis Fed data on U.S. banks with average assets greater than $1 billion.

Morgan Stanley expects the Fed’s first increase in borrowing costs since 2006 to happen in December. Since March, bank shares have climbed about 0.2 percent when 10-year Treasury yields increase, compared with a 0.1 percent loss when yields are lower, the firm’s study found.

Dollar, Profit

In the currency market, the surging dollar is expected to contribute to a 5.6 percent decline in first-quarter profit for S&P 500 companies, which according to S&P Dow Jones Indices derive 46 percent of their revenue overseas. Banks are less affected by currency fluctuations. Their earnings are forecast to be little changed in the January-March period, analyst estimates compiled by Bloomberg show.

A 5 percent gain in the dollar tends to coincide with an increase of about 1.5 percent in financial shares and a decline of about 1 percent in the overall equity market, according to data by Morgan Stanley.

‘‘Overweighting banks is prudent when the U.S. dollar appreciates,” Parker wrote in the note.

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