Monday, January 14th, 2013

Banks Are Back

Financials, Financials, Financials. In all our regional sector models, the biggest overweight is financials. It started with the US back in Q1 2012. Although the sector did not reach the top slot in that run, the speed with which it went from bottom three top to top three (just four weeks) suggested that the rally would be very powerful when it finally matured.

The first quarter turned out to be a false dawn and we had to wait for Mr Draghi to save the euro, before financials could enjoy their second leg of their rally. In mid-October UK financials gained the number one slot, followed by the US in early November. Eurozone financials did not get there until the last week of December – a late Christmas present for beaten-up bankers everywhere. So now we have had two weeks when financials are top of the rankings for all three major regions (and of course on a Pan-European basis).

It can’t get any better, but for the time being it looks as the party can continue beyond twelfth night. The new Basel guidelines on bank liquidity are less onerous than expected. The manufacturing slowdown has finally reached Germany, which has reduced the appetite for further austerity on the part of German politicians in an election year. It looks as though central banks, including Japan, will keep the printing presses running at full tilt and our industry contacts report that regulators appear to more sympathetic (less hostile) than they were a year ago.

This does not mean that the threat of disaster has been removed, but it is clear that investors now attach a lower probability to this outcome than they did a year or six months ago. Share prices are always a delicate balance between triumph and disaster. What matters is not the individual investor’s opinion, but the aggregate probability distribution of all investors’ opinions. In the final analysis, banks are healthier because the equity market says they are.

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