While there have been no shortage of reasons for investors to sell stocks in the last few weeks, it’s safe to say that a brewing credit crisis in China has not been on the top of the list. Linette Lopez of Business Insider wrote a very good piece yesterday titled “China’s Banks Are Getting Ready For A Debt Implosion” that detailed what many think will be an inevitable crisis after a dramatic credit expansion in the country over the past 5 years. I have no idea if an actual crisis occurs (though gdp growth has slowed even as stimulus has remained in place), but it’s hard to think, despite the economy being centrally controlled, that they will not follow the course of the west over the last six years with their own homegrown credit crisis.
Is the looming threat of such an implosion a reason to sell stocks now? Not really. It was no more threatening a year ago when the S&P500 was 1700, before going to 2000. However, it is certainly important to keep close tabs on the price action of some of the largest and most economically sensitive stocks in world, banks.
For instance, it is hard to ignore the relative weakness in European Banks, which by most accounts are wildly under-capitalized. Despite the ECB’s words, looking at the performance (or lack thereof) of the shares of Deutsche Bank, one would think we are more likely headed for another banking crisis in Europe, six years past ours and two/three years past Europe’s Sovereign Debt crisis:
Not surprisingly the chart of the same period of the EuroStoxx Bank Index (SX7E) looks very similar:
European banks’ structural undercapitalization has been discussed at length for years now. Unfortunately, the banking system has still not been adequately capitalized, with banks reliant on perpetual ECB funding in times of crisis.
On the flip side, the one positive for the U.S. banks is that they are much better capitalized than they were 7 years ago. As a result, the systemic concerns in the U.S. are much less of an issue, and the poor price action in European banks has not infected U.S. banks, which frequently happened in years past.
However, the consistent negative reaction to bank earnings in the past week (which were generally decent) might signal concern about global credit risks on the part of bank investors. While U.S. banks are better capitalized, if the credit markets start to price in more significant risk for European banks, U.S. banks are unlikely to escape unscathed. We’ll be keeping a close eye on European bank price action in the coming weeks, which will be a key barometer for the risks of a deeper correction in global financial markets.