In a market characterised by a boom in a small number of artificial intelligence and tech-related names, have banking stocks been flying under the radar?
Equities have started the year on the front foot. World stock markets have notched modest gains, with a number of US tech giants already posting double digit returns for the year. Leading the way is artificial intelligence champion Nvidia, which is up well over 50%1. Bond investors have been less lucky. So far this year, core US inflation has run at a 4%+ annualised rate, defying expectations that price increases will smoothly slow. That stubborn inflation has pushed up expectations for interest rates, with the 2-year Treasury yield rising to 5%. As bond yields have risen, their prices have fallen2.
The date is March 9th, 2023, and the next day, Silicon Valley Bank (SVB) collapsed as losses on its bond portfolio prompted a run by its depositors. Credit Suisse and First Republic fell in its wake, leading to unorthodox interventions from authorities and fear of banking contagion rippling through global markets.
Given that panic, it is remarkable to be back where we were just over a year ago—every observation in the first paragraph also applies year to date in 2024. Interest rate expectations have gone on a round trip, inflation is still running hot, and the tech titans are still thriving. (In another echo of early 2023, a small bank called Republic First collapsed just last week.)
More remarkable still is that the banks held in the Orbis Strategies the day before SVB collapsed have outperformed since then. Who would have imagined that the last year would be a rewarding time to own selected banks?
That they have survived did not surprise us. Most of our Strategies were overweight banks, but we held none in the US, and those we did hold were better capitalised, more diversified, and more conservatively run than the banks that got in trouble. Our core group was a diverse bunch, including Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial Group (MUFG), and Sumitomo Mitsui Trust Holdings in Japan; AIB, Bank of Ireland, and ING in Europe, and KB Financial, Shinhan Financial, and Hana Financial in Korea. All but MUFG are still significant holdings in at least one of our Strategies, and all but Bank of Ireland have outperformed both world stock markets and world banks in local currency terms.
Common to all is how banks make money. In essence, they try to lend money out at higher rates than they pay on the deposits they take in, profiting on the spread. That spread tends to be wider when rates are rising, but in the years following the global financial crisis, central banks kept interest rates pinned to the floor, starving banks from earning a hearty spread on their loans.
Since 2021, inflation has come roaring back, fanned by the pandemic and conflict in Ukraine, and central banks have raised rates to turn down the heat. This has allowed the banks to earn a good return on loans again, and has flowed through to healthy profits.
