On Thursday, the S&P 500 hit a new all-time intraday high, and eased off a bit but well in the green in the early afternoon. The market is being bolstered by some good macroeconomic news, like jobless claims dropping to lower-than-expected levels. It seems less people are getting fired and more people may be able to find jobs in the future.
This is good for companies, of course, because the U.S. consumer drives the bulk of the top line and bottom line of most S&P companies. But there’s another parallel trend that is even better: banks are doing much better than expected. Bank of America’s profits are higher than expected, Morgan Stanley’s earnings beat analysts’ estimates, and Goldman Sachs had more trading and investment income than expected.
Banks are a controversial and widely despised sector, but their health means more than just fatter bonuses for employees and greater stock prices for their investors. It’s also a forward-looking indicator of macroeconomic health.
The Virtuous Cycle
With the very important exception of credit bubbles, higher bank revenues tend to mean more lending throughout the market, and more lending means more capital in the economy, which in turn means greater ability to expand, invest, and experiment for businesses of all sizes that depend on the credit markets. I reported a few weeks ago that hedge funds are excited at opportunities in the credit market; those opportunities are already turning into profits.
This is good because greater credit means more investment activity, which can also mean more jobs and more consumer spending. It also means more confidence will spread in the marketplace. The banks have already demonstrated their confidence with higher lending revenues. In 2009 and 2010, banks feared lending to just about anyone, and it was almost impossible for anyone but the most qualified to get a loan. A lack of credit kills a capital-based economy.
Now we’re seeing an end of that cycle, and a return to more lending activity. It will take time, but the cycle of more banks lending to more investors investing to more people earning to more people spending means that America’s economy is very much on the rebound.
Or so the market believes. There remain two prominent risks: first is of a credit bubble forming, like the one we saw devastate the world in 2008 and 2009. Secondly, there is a risk of investors getting too ahead of themselves; the S&P 500 P/E ratio is at 19.53 after a steady climb throughout 2013. That ratio rarely hits 20, and when it does, stocks often fall to re-adjust. We may see some short-term corrections cause higher volatility, meaning long-term investors need to time their investments carefully and keep their eyes on the future. The need for well-informed asset management has never been greater.