The world of investments can be daunting, with a plethora of options and a constantly evolving market landscape. Given the high-profile bank collapses of SVB in US and the Credit Suisse in Switzerland over the last month, one sector that has been garnering a lot of attention lately is the Banking space.
In this article, I will provide a brief primer on the banking sector and share my insights on the current state of the market. So, let’s dive in right away.
Bank failures are more common than we think
Bank failures are not uncommon. In US alone, there have been 565 instances since 2000. Surprisingly, even during stable periods, banks have gone bust, with an average of two collapses per month between 2011 and 2020. That is quite something isn’t it?
Here’s the link for the FDIC data: https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/
What makes the recent failures of Silicon Valley and Signature Bank in US stand out are not just their size as the second and third-largest bank failures in US history, but also the time since the last bank failure in US, which happened in October 2020. The 868-day lull between the two failures is the second-longest stretch on record, with the longest being in the run-up to the 2008 financial crisis.
The Fed has been putting on bandages to balance the economy, rates and the defaults. Given the tricky situation the Fed finds itself in, watch out for many more surprises to come in the coming months.
The Indian Banking Outlook
In India, failures are less common due to high restrictions imposed by RBI. But there have been several high-profile cases in recent years. The collapse of Yes Bank in March 2020 and the PMC Bank's failure in September 2019 comes to mind that left many customers in distress.
The leverage in our banking system is far lower as compared to US and European banks, thanks to the strict regulatory requirements in place. Overall, banks and NBFCs have outperformed the market in the last one year or so, primarily driven by two factors-
A. Balance sheets are looking much cleaner post the write offs due to covid.
B. Delayed pass on of higher interest rates to the depositors leading to margin accretion in the past few quarters.
There are two main concerns apart from impact of the fear of global banking crisis,
1. Deposit growth has lagged loan growth for many quarters now with banks plush with funds to lend out money. However, in the coming quarters, banks will look to shore up their deposit books – leading to higher interest rates on deposits and thus, pressure on the cost lines of the banks. There is always a delay to pass on the benefits on higher interest rates to depositors while the loans get re-rated at higher rates quickly. The deposit rates have already inched up towards 7.5-8% - a fair deal in my opinion. However, I still feel that rates have not peaked just yet. Keep some of those cheques ready, for Fixed Deposits might just be one of the better investment alternatives for a while.
2. This also bring us to the second part, increasing cost of capital. There is no easy money anymore. With banks raising money at 8-9%, loan rates will shoot up as well and those low teaser floating rates of 6-7% issued in the last few years will have their loan tenures increased!
The increased burden of higher EMIs for retail loans and higher credit costs for corporates will lead to defaults in the economy and the cycle will repeat itself. This however, is a medium-term risk that could play out especially if inflation sustains. As things stand, Net Interest Margins should be relatively stable in the coming quarters but keep a close watch.
What does it mean for equity investments?
Overall, given the macro environment we are in, expect equity markets to be much more volatile in the coming years to come. There will be pockets where there is value to be found, but overall markets might be range bound for a while. For someone who is entering in the current market, it might be a better alternative to spread your investments across debt, equity and gold rather than coming overboard in equities.
Another aspect as to why I believe markets could stay range bound is the behavioral aspect. Market participants are still optimistic on the return prospects, as the 2020-2022 rally is still fresh in our minds. It feels sort of a situation where Akbar said to Anarkali in Mughal-E-Azam, “Salim (domestic flows) tujhe marne nahi dega, aur hum (high inflation, high interest rates) tumhe jeene nahi denge.”
Lastly, the valuation score analysis also seems to suggest that market returns might be flat for the time being. Below is the chart of Nifty 50 and Nifty 500 Index for broader market perspective. As a benchmark, if the valuation score is below 20%, I take it as my BUY trigger and if the score is above 90% it acts as the SELL trigger. However, as we will cover in the upcoming articles, the BUY and SELL levels are different for different indexes. We cannot measure everything with the same yardstick.
Nifty 50 Valuation Chart
The recent correction has offered some comfort on valuations to take up initial positions in certain pockets of the market. I personally do not expect very sharp corrections from here. If that happens, it should be a good buying opportunity.
As for the technical setup, I expect Nifty 50 Index to continue to respect the 16,500 to 18,500 range broadly in the coming months. For a sustained rally, Nifty will need to hold above the 18,000 mark.
If we look at the broader markets (Nifty 500 Index) as well, it is indicating a similar story. Range round market for a while.
NIFTY 500 Valuation Chart
That was the broad level view on the markets and the recent events. In the next article, I will cover the Banking and Financial sector in more detail to see if there are any value opportunities. The plan is to gradually evaluate each sector in the coming weeks as I scale up my research coverage.
Hope you found this useful. Appreciate your feedback to help me improve!
Warm Regards,
Shivam Jain
Disclosure: I’m not a SEBI Registered Investment Advisor. All content on this website is purely for educational purpose. Please consult your financial advisor before making any decision.
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