Must Read Research

Also featuring commentary from Global Economic Weekly

February 25, 2024

Candace Browning

Candace Browning, Head of BofA Global Research

Longer days have brought stronger rallies. This week we discuss fresh 34-year highs in Japan equities and three ways to revive European banks.

 

The Nikkei 225, Japan’s benchmark equity index, closed at new highs this week for the first time since 1989.

 

Japan Equity Strategist Masashi Akutsu thinks higher real wages and a manufacturing recovery will continue to bolster fundamentals. Management teams are also expected to disclose plans to improve capital efficiency when full-year earnings are released in May. Shareholder-friendly policies are in vogue as the total value of buybacks and the number of companies repurchasing shares were at their highest levels since FY (Fiscal Year) 09. Dividend forecast revisions are also well above the 10-year average. Index returns are expected to be modest for the rest of 2024 with a year-end price target of 41,000 (+5% from Friday’s close). The team highlights 61 quality cyclical stocks with high ROE (return on equity), low leverage, and resilient earnings expectations. Consistent with expectations for volatility and somewhat less upside ahead, Chief Investment Strategist Michael Hartnett notes that the Nikkei is discounting a big jump in the ISM manufacturing index. He recommends going “long producer” cyclical assets like South Korea, Sweden, Germany, and EM ex-China as the ISM inflects higher.

 

European banks are in need of AI-like dynamism.

 

Banks offer shareholders 12% cash yield on highly capitalized and liquid balance sheets, but Head of European Banks Equity Research Alastair Ryan argues that they don’t do much anymore. European banks have added little to no loan growth in the past 15 years, creating the “stability of a graveyard” that authorities didn’t seek. Non-bank lending has increased and record-high 16-18% Cost-of-Equity makes required returns on new lending too high for politicians to bear. In Alastair’s view, three post-crisis reforms should be reconsidered for banks to re-rate and support Europe’s recovery: 1) Global Systemically Important Bank (G-SIB) thresholds should be indexed. Buffers were set a decade ago, before 40-60% economic growth, and tipping into more highly scrutinized buckets can cost banks 8% of market cap; 2) Liquidity Coverage Ratios (LCR) should reset from the current 158% toward the required 100% to restore balance and potentially mobilize €1.8 trillion of trapped liquidity in the euro area alone; and 3) more balanced stress tests would free more capital to lend.

Featuring Commentary from Global Economics Weekly

Claudio Irigoyen

Claudio Irigoyen, Head of Global Economics, BofA Global Research

The option value of waiting

 

The Fed minutes last week showed that Fed officials are concerned about upside inflation risks. ECB minutes had a hawkish tone, with a focus on wages as expected. China stimulus continues coming piecemeal despite the recent policy easing, while consumer and business confidence remain depressed. In all cases, policymakers rely on the option value of waiting before deciding their next policy move.

 

Interestingly, since starting the easing cycle in the U.S. and Euro Area or a significant increase in policy support in China can be considered as highly irreversible decisions, the option value of waiting to get more data becomes relevant. Such option value differs significantly across the three main economies. It is higher for the Fed, somewhere in the middle for the ECB and certainly much lower for Chinese policymakers.

 

As we discussed before the January FOMC meeting, upside risks to inflation in the U.S. were significantly underpriced by markets. In a nutshell, the economy is at full employment, the labor market is tight, consumption remains resilient, fiscal policy is too procyclical, and disinflation has been mostly driven by supply factors.

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