Bank earnings embody abiding uncertainty

London: Compare the sentiment of investors now with that of a year ago and it could not be more different. Safety, cash flow and caution are the watchwords, as against the expectations for growth and recovery that greeted the start of 2011.

Yet in some respects the only difference between now and a year ago is the speed with which divergent market views have become apparent. In the first quarter of 2011 financial stocks rallied on hopes for the economy, while strong demand for government bonds in a February auction foretold the rush for safety that was to come.

This year there have been similar moves in just two weeks. On Wednesday there was record demand for US government ten-year notes. Judged by the amount of bidding for debt, demand was at the third-highest level on record.

Investors, it seems, are prepared to suffer the slow erosion of their capital by inflation, which is higher than the 1.9 per cent yield they will receive, for the guarantee that they will at least get their money back, $21 billion (Dh77 billion) of new paper which was snapped up by the market.

In the same two weeks the US banks have rallied hard, however. The question is what it means for the rest of the market. In part, it is just a catch-up from last year, when six of the worst-performing stocks in the S&P 500 were large banks. In what ConvergEx has dubbed the Lazarus Rally, those six have led the sector upwards.

The US bank rally also follows gains for Spanish banks in December. With bans on short selling in place in parts of Europe, the US banks have been used as proxies for their European peers.

Such fears are now receding. Yet the earnings season is expected to be lacklustre, and the banks epitomise the uncertainty that hangs over the economy and the stock market. Trading on about 7.5 times expectations for this year's earnings, they are reasonably cheap.

Funding costs have come down. Yet there is still little demand for credit. And, for the investment banks trading volumes continue to fall, So the future is nowhere near as bad as it seemed in the summer last year. But remember that better than feared is not yet a rosy long-term prognosis. There is still an awful lot of money paying for the safety of US government bonds.

— Financial Times