Talking Heads – Actions américaines: C’est un bon moment pour les « sélectionneurs de titres»

This is an article based on the transcript of the recording of this Talking Heads podcast

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing what’s going on currently in US equity markets. I’m Andy Craig, Co-Head of the Investment Insight Centre. This week, I’m joined by Jeff Dailey, Deputy Head of US Equities. Welcome, Geoff, and thanks for joining me.

Geoff Dailey: Thank you. Happy to be here.

AC: The last weekend in April saw First Republic Bank become the third bank to be taken over by US regulators in the past two months with the Federal Deposit Insurance Corporation (FDIC) brokering a takeover by JPMorgan. Can you give us an update on the health of the US banking system since the mid-March failure of Silicon Valley Bank and Signature Bank.

GD: We’re now at the tail-end of first-quarter earnings for banks, so we have fresh data on the extent of the ‘deposit [outflow] contagion’ that was experienced in mid-March. With the exception of select names that we’ve heard about in the headlines, banks demonstrated resilient deposit trends. The median deposit decline for banks in the US was a manageable one and a half percent. The decline that we saw for most banks was primarily a function of higher interest rates and quantitative tightening, not widespread deposit panic. There were a few select banks that had deposit outflows of more than 10%. One of the largest outliers was First Republic. It experienced a 40% decline in deposits . Importantly, all First Republic depositors were backed by the strength of JPMorgan. It is good for the stability of the banking system to have that resolved. There are other mid-sized banks in the top-100 that experienced material deposit outflows. These banks have created additional angst and volatility in the regional bank space, given speculation as to their ability to weather this environment. It’s still feasible another regional bank or two is taken into receivership by the FDIC. But in our view, if this were to occur would be a much smaller bank than First Republic and it would be manageable for the banking system. It’s worth highlighting that all three banks that have failed so far are unique among regional banks. They had high levels of uninsured deposits, customer concentration issues, and in a couple of instances poor asset/liability management. The vast majority of US banks have much more diversified deposit bases. They have a lower level of uninsured deposits and better asset/liability management. It’s not a widespread issue within regional banks. While there was general deposit stability across the banking system this quarter, funding costs have accelerated. We expect that to continue until the Federal Reserve pauses [Its rate rising policy]. That’s an incremental headwind. We also expect deposits to continue to migrate out of the banking system given the impact of quantitative tightening, but this should be at a manageable rate. These trends have been in place for some time. On the credit side, credit quality for banks has been exceptionally strong. Both net charge-offs and non-performing loans have been at low levels and the first-quarter results have continued to show benign credit quality. As we look forward, higher interest rates, credit tightening and some softening of the economic fundamentals will ultimately lead to higher credit costs for the industry. Commercial real estate and offices in particular are areas of focus as higher rates and deteriorating fundamentals in the office space are creating pressure. It’s worth paying close attention to how these segments play out. But any credit deterioration will occur over an extended timeframe in our view. The vast majority of banks is starting from benign levels and is in solid shape. But we are paying close attention to the credit side as well as the deposit side.

AC: Taking a step back, what do you see as the implications for the banking sector and for the broader US equity market of the turbulence over the two months?

GD: We’ll definitely see enhanced regulation. Regulators are in the process of forming more stringent requirements. It’s likely that regulations will focus on greater liquidity, higher capital ratios and more intense stress-testing. The regulations will likely focus on that subset of banks below the largest money centre banks. They already have the most stringent regulatory requirements. Banks between with US 100 billion and USD 700 billion in assets will face a more difficult regulatory roadmap. We think these new requirements will be phased in over a considerable period of time, likely years. So, they’ll allow the banks to gradually adjust. The intent of regulators is to strengthen the system, not destabilise it, so we do not anticipate any forced capital raises, but a smooth transition for these banks to let them grow organically into higher capital ratios. It’s feasible we will see some incremental regulatory requirements for smaller banks. Regulators really don’t want to unduly burden the community bank system in the United States, given they’re so vital to local communities. And regulators don’t see the smaller banks as a systemic risk. Longer term, this will have a negative effect on profitability for regional banks. But it’s worth pointing out that they’re starting from a high level of returns. Another result of the turmoil is that banks are going to increase their on-balance sheet liquidity, so they’ll have more cash on their balance sheets, which will impact their ability to earn spread income and weigh on their net interest income growth. Banks will also preserve capital and tighten their loan growth expectations, so they’ll be lending less. That’s going to be a headwind to earnings growth. There’s an impact on the broader economy. As banks preserve this capital and tighten their underwriting, they’re going to be more discerning with lending. Corporations, consumers, real estate investors are going to have less access to capital to be able to grow or invest in their businesses. There’s a knock-on effect: the economy will slow to a degree. On the positive side, from the Fed’s perspective, this helps it accomplish its inflation-fighting goals faster than anticipated. Jerome Powell, chair of the Fed, referenced this impact in recent remarks. We’re likely to see a pause by the Fed sooner than the central bank itself anticipated. This would be positive for the market.

AC: How do you see the wider earnings trends at this stage in the reporting cycle?

GD: It’s been a volatile reporting season with company-specific drivers generating sharp moves. Earnings misses are being punished and large earnings beats are needed for stocks to be rewarded. In terms of general trends, we’re seeing signs of softness in certain verticals with tighter financial conditions being cited, but we’re also seeing signs of bottoming in certain industries that entered the down cycle earlier. There are some areas of resiliency as well. I’ll give some examples that show this dichotomy.

Within semiconductors, the inventory correction that was experienced in PCs and smartphones is bottoming out. This segment demonstrated weakness early in the cycle and appears to be inflecting positively in the back half of the year. That’s positive. Within semiconductors, the automotive sector has been resilient throughout and remains so, while in semiconductors used for datacentres, there’s still considerable debate on the mixed outlook on cloud spending. Cloud spend did decelerate in the first quarter, but remains pretty robust with the big three [suppliers] reporting 20% growth. We are seeing light at the end of the tunnel for cloud spend: New workloads are starting; artificial intelligence is an emerging key driver and comparatives are getting progressively easier. Select tech verticals that have been decelerating for some time now are approaching a potential inflection point in the back half of the year.

Within healthcare, we’re seeing positive trends in medical technology. Elective procedural volumes are improving as staffing improves, so capacity is increasing. That’s a positive. On the other hand, we have industries like life science tools that depend on biotech and biopharma spending. They’re seeing softness because of the tightening conditions in lending and access to capital.

Industrials is another space with a mixed picture. Capital goods companies have generated solid revenues and margins this quarter. Supply chains have opened up and firms were able to ship finished product. They generally gave positive outlooks. Not all these results were met with positive stock reactions, however, as the market’s sceptical of the economic outlook in the second half.

On the construction front, non-residential construction has held up well, with companies citing megaprojects, stimulus and strong backlogs as reasons for confidence. Public sector strength is offsetting softness in the private sector – that’s been weighed down by the availability of credit.

The US freight market is an area demonstrating softness. Shipments for truckers were down 8% this quarter and rail traffic is down as well. This aligns with softness in some consumer end markets.

We are in a dynamic market: we’ve seen mixed signals, industry softening, and some [sectors] inflecting. Overall, we think it’s a great time to be a stock picker.

AC: That’s a comprehensive review. Thank you for joining me. GD: Happy to be here and thanks for the time.