Bank stocks 17pc overvalued based on bonds

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New research that extends the equity risk premium framework to bank stocks implies they face downside risks.

. The so-called Sahm rule suggests that a US recession is under way when the three-month moving average of the unemployment rate rises by 0.5 of a percentage point or more from its low during the prior 12-month period. This model has correctly identified all US recessions since 1950.Taking the Fed’s survey of professional forecasters, we find that the median economist in the US is anticipating only a trivially small rise in unemployment that would not meet the definition of a recession.

We found that recessions were much more common in the US, with 11 in total. By way of contrast, soft landings were relatively rare with only three over the past 73 years. Crucially, just one of these soft landings – in the mid-1990s – was successful in the sense that inflation subsequently settled around the central banks’ target.Since the 1950s, recessions have been accompanied by much higher inflation than soft landings.

He adds: “Yet history suggests that entrenched demand-side inflation is not particularly responsive to interest rates, which implies that a soft landing may not be enough to tame inflation.” Sadly, similar conclusions apply to Australia: bank equities have historically paid you a 6.5 per cent premium above their bonds, which is only 5.1 per cent currently using analyst earnings expectations . The return premium offered by bank equities over their bonds in Australia is likewise the worst documented since the GFC.

 

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