Dividends: U.S. and European Banks Are on Different Paths

By Markets Fool.com

February is in the books, and equity traders are kicking off the month of March on an optimistic note. TheS&P 500(SNPINDEX: ^GSPC)and theDow Jones Industrial Average(DJINDICES: ^DJI)(DJINDICES: $INDU) up 2.07% and 1.89%, respectively, at 2:43 p.m. ET.

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The price of oil is down today, thereby failing to display the positive correlation with stocks we've recently become accustomed to this year. Sure enough,Financial Times, citing Reuters' calculations, reportsthat "the five-day correlation between Brent crude and the S&P 500 fell from a positive 95 per cent last week to minus 20 per cent by mid-session on Tuesday."

The FT notes that the correlation "is likely to click back into place if energy prices move sharply down again, reviving global demand and commodity sector bankruptcy fears."

Although that sounds undesirable on the face of it, it would actually be favorable for long-term share buyers. Slavishly high correlations, to use the FT's language, reflect/create dislocations between price and intrinsic value.

Barclays is reduced its dividend by 54% as part of its new strategy. Source: Hakan Dahlstrom Photography, republished under CC BY 2.0.

Barclays' American Depositary Receipts fell as much as 8.2% on Tuesday morning (the London-traded shares were down more than 10%) as the U.K. lender took a machete to its dividend, reducing it 54% to 3 pence a share for 2016 and 2017. The cut is part of a broader restructuring under new chief executive Jes Staley that aims to create a more focused and better capitalized institution.

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The move exemplifies a divergence between the fortunes of the top European and U.S. universal banks. At the end of October, for example, Deutsche Bank AG announced that it would not pay a dividend this year or the next.

That divergence stems from a number of factors, the most consequential of which is the fact that European banks were much less aggressive in addressing the aftermath of the global financial crisis than their U.S. counterparts.That lack of urgency became part of an adverse feedback loop in which it simultaneously contributed to and was compounded by an anemic economic recovery.

Similarly, the European Central Bank (ECB) was initially less aggressive than the U.S. Federal Reserve in its attempts to spur growth and stave off deflation.

In trying to adapt to the economic environment, the ECB ultimately delved into the netherworld of negative interest rates in mid-2014. At the beginning of December, the ECB cut its deposit rate to (0.30%) (the deposit rate is the rate the ECB charges lenders on the reserves it holds on their behalf). Negative rates hurt banks' profitability, at least as far as their direct effect is concerned.

By contrast, in the U.S., there is good reason to believe that the Federal Reserve could sanction significant increases in capital return to shareholders by Bank of Americaand Citigroupthis month, including significant increases in the annual dividend. Both banks currently offer a dividend yield that is significantly below the 2.3% yield on the S&P 500 (by comparison, the yield on JPMorgan Chase shares tops 3%).

Results of the annual round of banking stress tests will be released in the next several weeks. As part of that exercise, top banks submit their capital return to the Federal Reserve for approval. Both B of A and Citi shares continue to trade at a discount to their tangible book value -- 15% for the former, a whopping 32% discount for Citi -- but March could produce a catalyst that will help close that gap.

The article Dividends: U.S. and European Banks Are on Different Paths originally appeared on Fool.com.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.