Banks led a stock market slide Monday, heightening concerns on Wall Street that their shares have peaked in value after a sensational yearlong run.
In late trading, virtually all the top 50 banking stocks were in retreat. The Standard & Poors bank index fell more than twice as much as the broad market S&P 500.
"We think the party is over," said banking industry analyst Fred A. Cummings of McDonald & Company Securities Inc., Cleveland, who Monday cut his group rating on bank stocks to "underperform" from "outperform."
"Valuations have reached 70% of the S&P 500, which is the high end of the historical range for these stocks," he said.
"Second, the banks are trading at about 10 times earnings now and our work suggests that banks (on average) don't trade above 10.5 times forward earnings, based on yearend closing prices," he said.
Both measures hint that there is relative little upside price potential left for banks at this juncture in the current business cycle, Mr. Cummings said.
More importantly, he said. "we are concerned about the earnings outlook for the group, given that the yield curve is very flat."
Even if the Federal Reserve eases credit further to support the economy, the analyst said, he does not expect to see the same degree of margin expansion that occurred in 1991-93.
The big reason for this, he said, is that savings account rates and NOW account rates at banks are already about as low as they can reasonably go. Little leverage is available to them this time from declining rates.
"The banks are benefiting to a degree from a shifting mix of assets," he said. "Still, funding costs are probably going to go up rather than down."
Mr. Cummings thinks that means overall bank earnings will grow a maximum of 11% to 12% in 1996, after coming off a relatively low base of growth this year.
But the analyst thinks that growth rate will be the last good news of this cycle. "We anticipate that 1997 earnings will only grow in the magnitude of 5% to 7%, with pressure from higher credit quality costs and sluggish net income growth."
In short, Mr. Cummings doesn't feel things will get better for the banking industry than they are now. And with many banks trading at full valuation levels, "this is a good time to be taking profits."
The analyst does recommend a handful of banks he feels have the earnings growth capacity to resist the downward trend in industry fundamentals. They are Norwest Corp. and First Bank System Inc., both of Minneapolis, and Fifth Third Bancorp of Cincinnati.
McDonald also still touts one remaining"value play" among banks: Mellon Bank Corp. Mr. Cummings said the Pittsburgh banking company "still looks cheap to us at less than nine times earnings."
Could banks break out of the historical pattern and keep rising to a new price-to-earnings level? The analyst doubts it when banks continue to lose market share to nonbank competitors in important areas of their business.
Also, Mr. Cummings feels the banks' return on equity has hit a cyclical high, particularly in light of the below-average problem credit expenses that banks have recently shown.
"We see returns on equity gradually declining, so it is hard to imagine (price-earnings) multiple expansion," he said. "The bank earnings outlook just does not support that."
