Finance

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

It's Bill Gross letter day, always an exciting time for fans of wacky anecdotes and financial-market commentary.

Sadly, Gross's monthly outlook is disappointing on two fronts this time. First, the anecdote isn't that wacky and isn't one of his best. It's about how one day the sun will burn itself out and actually consume the Earth, "first contracting, then expanding like a flaming candle turned firecracker."

Fair enough Bill, but we've heard this story before. And most of us aren't too worried about hedging the duration risk of the sun since this is still a few billion years away. (Can't we hear more about "Delos Roman," the tough guy from your high school who had a physique that "resembled that of Zeus, the God of Thunder?")

The second disappointment is more pressing. It's that the sun isn't the only thing burning out:

You should be aware that our finance based economic system which like the Sun has provided life and productive growth for a long, long time – is running out of fuel and that its remaining time span is something less than 5 billion years.

The former Bond King touches on a quandary that value-oriented equity investors everywhere are contemplating: the rock-bottom multiples that many bank and assorted financial stocks reached this year, enticing knife-catchers to stretch out their delicate palms in the last month and push the KBW Banks Index up 14 percent.

The pummeling of bank shares wasn't about their exposure to potential defaults from the oil and commodities bust, in Gross's view. Instead, the persistent low and even negative interest rates that are being championed by central banks have made the outlook for their returns on equity look like utility companies. (We're guessing there are few things that get under a banker's skin more than being compared to a utility, so tip o' the hat to Gross for some solid trolling there.)

This isn't an unusual appraisal of banks in the post-Dodd-Frank, zero-percent interest-rate world. Here's a look back on the differences in ROE between banks and utilities, which indeed are looking similar after banks were way ahead before the crisis and way below during it:   

Will ROE Return?
The return on equity for bank stocks remains well below pre-crisis levels.
Source: Bloomberg

And banks lose when it comes to what matters most to utility investors, dividends. The slide in bank stocks and outperformance in utilities has narrowed the gap in dividend yields somewhat, but the two are still pretty far apart:  

Yield Hockey
Utility dividend yields have come down, but they're still much higher than those for banks.
Source: Bloomberg

To bring it back to Gross, he advises investors not be lured into the come-hither price-to-book ratios of bank stocks. His alternative? Stick to short-duration bonds and lever up "mildly" and -- hey, what a coincidence! -- you can do that with his Janus unconstrained bond funds. 

But for those obliged to put money to work in the equity market, the question is whether he's right and investors should stay away from these bank shares that are still flashing enticing valuations even after a sharp rebound.

Come Hither
Even after a sharp rebound, many banks are still trading below book value.
Source: Bloomberg

The biggest risk to that call would be if the Federal Reserve actually listens to Gross and other critics of low rates and continues to push rates higher without blinking at any ensuing financial-market volatility. And certainly the purge that sent the KBW Bank Index down 30 percent from July through last month seems like an exaggeration at this point. Still, the pessimists aren't going away. Just on Thursday, JPMorgan Chase strategist Jan Loeys took the rare step of advising investors to underweight the whole lot of global equities, saying the risk of recession has increased with economic models now showing a one-third probability the U.S. expansion will stop within the next year and a 100 percent chance it's over within three years. If a recession really is in the cards, those low valuation multiples will seem prescient in the rear-view mirror. 

It's possible the truth may lie somewhere in the middle -- the sun may not have run out of fuel, but it's just too cloudy at the moment to say for sure. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. One could argue there are actually three major disappointments if you count the crimes against standard punctuation laws committed in this sentence. 

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net