Equity markets corrected significantly over the last week on the back of lacklustre economic data. Though the S&P 500 may still be up from its November low, the same cannot be said about the U.S. banking sector which dropped to a new cyclical low. This performance is unsettling since our research shows that equity markets are unlikely to embark on a sustainable rebound without the participation of financials. Banks tend to outperform the rest of the market in end-of-recession rallies.

Will the market enter a consolidation phase or is it heading for a new down leg? While we recognize that the outlook for banks remains challenging, there are nonetheless four notable differences between the present situation of the banking industry and the one that prevailed at the height of the credit crisis last October:

1) The weakness is not as global as it was back then. The S&P Global 1200 bank and the S&P/TSX Bank indexes are both above their recent lows (6.3% and 5.5% respectively).

2) The LIBOR-OIS spread (overnight financing costs for banks) remains firmly below 100 b.p. (where it stood before the Lehman debacle) whereas it reached 364 b.p. on October 10.

3) With respect to credit markets, the tone remains relatively good with continued reduction in liquidity premiums in the cash bond market. Recent new issues, even in the high yield segment, have been relatively successful

4) Since October, governments around the world have taken major steps to revive the global economy. G-20 finance ministers are working on large stimulus packages and we have seen several announcements by central banks to encourage consumption.

Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Investment Advisor
Associate Portfolio Manager
e-mail: mounir.el-ayari@nbf.ca