Deflation has hit Europe and Japan with negative interest rates. Now when some folks put money in the bank they need to pay interest to keep it there. Warren Buffett joked that if he had a really big mattress he would use it to save his money from the European insurance company he owns. How does this work out for banks. What will negative rates do to bank stocks? CNBC interviewed Bill Gross a widely followed investor. He says to avoid bank stocks when rates are negative.
Bill Gross, the widely followed investor who runs the Janus Global Unconstrained Bond Fund, said on Thursday that investors should not be tempted into purchasing beaten-down bank stocks against the backdrop of interest rates potentially turning negative.
In his latest Investment Outlook report, Gross said negative yields threaten bank profit margins as yield curves flatten worldwide and bank net interest rate margins narrow.
“The recent collapse in worldwide bank stock prices can be explained not so much by potential defaults in the energy/commodity complex, as by investor recognition that banks are now not only being more tightly regulated, but that future Return On Equity’s will be much akin to a utility stock.”
Gross warned investors: “Banking/finance seems to be either a screaming sector ready to be bought or a permanently damaged victim of write-offs, tighter regulation and significantly lower future margins. I’ll vote for the latter.”
It would appear that bank stocks have taken a hit for good reasons. Gross likens banks to utilities in the future.
More Bad News for Banks
Barrons adds its voice saying that bank stocks are vulnerable as rates fall.
Given that banks are once again underperforming the broader market, however, and the yield curve itself is actually flatter now than it was in November, it seems that the market has a different outlook. And that does not bode well for further interest rate increases.
By December, even before the Fed actually raised rates, conditions changed. Banks stocks were lagging again and the spread, or difference, between the yield on the 10-year Treasury note and the two-year Treasury note – called the 10-2 or 2-10 spread – shrunk to the extremely narrow levels seen in July 2012 and February 2015.
One might think that when banks are going to charge you interest to hold your money that it would be a profitable business model. But remember that in a negative interest rate world banks would need to pay you to borrow their money! What will negative rates do to bank stocks? They won’t do anything good. So, when might rates go up and fix this situation?
The Future of Interest Rates
Interest rates will go up when the economic picture improves and that might be a while. The Telegraph in the UK sees the first rise in interest rates in August 2019.
The prediction had been for a rise in December 2016 or January 2017 for the UK Bank Rate, following the first rate rise in the US for nine years, in December. But fresh global economic gloom in 2016 and the comments of the Monetary Policy Committee (January 14) shifted opinion. Now money markets imply that the first increase will come in August 2019, following dramatic movements in the market in the past few weeks.
In the meantime low or negative rates will be bad for bank stocks so avoid them.