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Big gains are ahead for the big banks, Goldman Sachs analyst predicts

  • Big banks are set to benefit from a surge in buybacks and dividends, Goldman Sachs analyst Richard Ramsden said.
  • After surging nearly 30 percent following Donald Trump's Nov. 8 presidential election victory, bank shares have traded in a range since mid-February.

Big-bank stocks could be ready to make a move after a five-month run of doing pretty much nothing, according to a Goldman Sachs analysis.

A surge in dividends and share buybacks coupled with growing prospects of regulatory rollbacks are bolstering the case for the largest financial institutions, analyst Richard Ramsden said in a research note.

After surging nearly 30 percent following Donald Trump's Nov. 8 presidential election victory, bank shares have traded in a range since mid-February. Investors have cooled on the sector as interest rates have not gone up as much as anticipated and Trump's legislative agenda has stalled in Congress. For the year, the KBW Nasdaq Bank Index has risen nearly 4.5 percent and is underperforming the S&P 500's 10.9 percent gain.

However, Ramsden thinks the market is underestimating the gains banks could reap from deregulation that is still likely to come, albeit delayed. The analysis suggests that the initial pro-Trump bank rally came with a 12 percent premium baked in on deregulation. Since then, he estimates, that premium has fallen to 2 percent.

"A macro model of bank equity performance based on S&P 500 and interest rates
suggests that very little optimism regarding deregulation is currently being priced by
bank shares," he wrote. "Given how small this premium is, if we see further
progress on deregulation or on corporate tax reform, we see potential upside for the
stocks."

Corporate New York skyline
Toshi Sasaki | Getty Images

Buybacks and dividends also will provide upside for banks, particularly considering another positive round of stress tests. The Federal Reserve each year tests banks for how well they would stand up to another financial crisis, then decides whether to allow the banks to return capital to shareholders.

Following the latest tests, the Fed approved an aggregate 36 percent increase in dividends and an average $9.8 billion of share buybacks per bank. In the next two years, Goldman projects that banks will carry a dividend yield of 2.8 percent, compared to 2.3 percent for the S&P 500.

Subsequently, that would provide incentive for mutual fund managers, currently underweight banks, to rebalance and add financials.

In all, Goldman expects large-cap capital return to shareholders to grow 19 percent through 2020. This would provide "downside support" for investors in a market that is expected to show increasing volatility ahead, Ramsden wrote.

Bank results from second-quarter earnings were fairly strong, with 65 percent beating analyst estimates though several showed declines in trading revenues that spooked investors.

Clarification: This report was updated to clarify that the amount of buybacks is an average.

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