Insider Q&A: KBW research head Cannon on rates, banks

WASHINGTON – Global stock markets have been turbulent and fairly scary this year. Following a rally this week, the U.S. market is down about 4 per cent since the start of the year. Bank stocks have been hit especially hard. One of the prominent developments in the mix is the historic interest-rate hike by the Federal Reserve in December.

Frederick Cannon, global director of research and chief equity strategist at Keefe, Bruyette & Woods, sees both good and bad news for banks in the current environment and some potential bright spots for investors. The Q&A has been edited for clarity and length.


Q: What about the impact of the Fed’s interest-rate increase, the first in nearly a decade?

A: For the banking system, the Fed rate rise may have been “be careful what you ask for.” Banks had been looking forward to the Fed raising interest rates and being able to get a better spread on their loans. (The difference between the interest rate a bank pays on money it borrows and the usually higher rate it charges its borrowers.)

Q: With the recent economic anxiety and market turmoil, Fed Chair Janet Yellen now is saying the pace of Fed interest-rate increases could slow. And so?

A: Now we’re in a situation where certainly players in the market are thinking, “Well the Fed isn’t going to raise rates much more, that means we don’t get a benefit there, and it certainly looks like credit costs are going to go higher, even if they’re not going to go a lot higher.” And suddenly what had been viewed as tail winds have shifted, and they now look like headwinds for bank earnings.

For the banking system as a whole we believe the capital at the banks is much higher than it was back in 2008, the balance sheet seems strong; but there are some very real earnings headwinds for the banks.

Q: In the current environment, do you see stock-market sectors that you think will do well in the near future?

A: I would say it’s not all bad for financials. One of the sectors that we’ve seen do quite well and should continue to do quite well are the exchanges. We look at the Chicago Mercantile Exchange, the IntercontinentalExchange, Nasdaq. (They benefit) because there’s greater volatility in the market.

One of the sectors that performed horribly last year is the mortgage REITS (real estate investment trusts). And now if interest rates are really going to stay at these low levels and the Fed isn’t going to be raising rates, the strong yields on mortgage REITS where investors can earn 8 to 12 per cent dividends are starting to look more appealing. And so I think that we could see one of the sectors that performed extremely poorly last year, when it looked like the Fed was going to be raising interest rates, could start to see a lot more investment.

Q: Are there any foreign investment opportunities that you see?

A: If investors want cheap bank stocks, they don’t need to look in the U.S.; they can look over toward Europe. That said, we do think there’s a lot of risk over there, that investors are wise to do a lot of digging in to understanding the banks. The only area we might point to is the Nordic region, where the banks have already had to deal with negative interest rates for quite some time. So they could already be the banks that know how to survive in this environment.