Investment - Articles - Real & perceived risk - & restoration of faith in equities

 Last month, post a severe stress test of US banks, the Federal Reserve signed off on plans for banks to return substantial quantities of capital to shareholders via dividends and buybacks. Given what we have been through in the last 5 years, regulators have become very conservative and the recent stress tests in the US were written accordingly: banks must show that they are able to maintain risk-weighted capital (the so-called Tier 1 ratio) of 5%, amid a decline in real GDP of 5%, unemployment of 13.1%, a 52% fall in the stock market and a further 21% drop in house prices which are already very low.

 So, why should we care? Plans to return capital in the US and more specifically the regulators comfort with those plans is saying something quite fundamental: the financial system is safe. In contrast, we live in a financial world where assets remain priced for some systemic "stress" - equities are cheap on most measures, G3 bond yields are very low and corporate credit spreads remain wide relative to their history.

 In my view there is an increasing contrast between the real risks and the financial markets interpretation of the risks and when that happens there is only one thing that a corporate can do - put their money where their mouth is. Given the huge amount of cash on US corporate balance sheets (15% excluding financials), it's been inevitable that we would see increased dividends, more buybacks and more M&A. With US financials now being allowed to join in and publishing plans to that effect, this could be the catalyst that begins to restore investors' faith in equities.