Ahead of the Curve | Friday, 15th October 2021

Stagflation fears rising despite resilient demand
Rising inflation expectations amidst what is likely to be peak growth acceleration coming out of the throes of the pandemic and unprecedented fiscal responses is raising concerns of a stagflationary economic environment.  Supply chain bottlenecks have persisted longer than expected, and are drawing comparisons to the Great Inflation of the 1970s.  While we do believe that some of the parallels between the simultaneous presence of shortages and high inflation are apt, a prolonged stagflationary environment is unlikely.  We would need to see demand destruction for that to be the case, but in fact are seeing the opposite: households have record excess savings, consumer spending in many economies today is higher than pre-pandemic levels, unemployment is falling, nominal/real rates are low, and wage pressures are relatively limited.  Where we do see supply shortages causing reduced short-term production/sales, this is often simply getting pushed back into 2022 from 2021.  As a result, we expect the growth outlook to remain supportive and more reflective of a reflationary environment than a stagflationary one.

Emerging “greenflation” likely to characterize the 2020s
Rising energy prices have also been capturing the market’s attention recently.  While partially related to some of the supply chain issues, they seem to be shedding light on a more fundamental trend.  Fossil fuel investment is unlikely to rebound going forward as ESG mandates force banks and investors to cut off financing.  This suggests clean energy transition driven inflation, or “greenflation,” is likely to be an enduring characteristic of the 2020s, much as persistent disinflation characterized the 2010s.  It also highlights the immense amount of investment in clean energy supply that needs to occur for renewables to eventually replace fossil fuels.  We are clearly only at the beginning stages of what is likely to be a sustained clean energy investment boom in that regard – which will be highly supportive of growth.  Banks are likely to be beneficiaries of this both from higher interest rates and higher loan growth as they will undoubtedly be partners with governments in helping to finance this undertaking.

BNP Paribas to part ways with Bank of the West?  A strong potential catalyst
For months, investors have been pressuring BNP Paribas to sell or otherwise monetize its US subsidiary, Bank of the West.  This comes as BBVA sold its subsidiary Compass Bancshares to PNC, and Mitsubishi UFJ sold its subsidiary Union Bank to US Bancorp.  Both transactions created significant value for both sides via synergies and release of capital for the sellers.  Both BBVA and MUFJ have indicated they will return some of the proceeds to shareholders via buybacks, which have been well received.  A similar transaction for BNP could be great catalyst as Bank of the West only accounts for 4% of earnings but could be worth 15-20% of BNP’s market cap.  Alternatively, BNP could also IPO Bank of the West, and gradually sell down its stake over time, much as it did with First Hawaiian Bank in 2016, fully exiting in 2019.  Either route would significantly boost capital, allowing them to return capital via buybacks, which could drive total yields for the stock north of 10%.  Given the undemanding 8x P/E valuation standalone, the investment case for BNP looks even more attractive in light of the strategic and financial merits of either a sale or IPO of Bank of the West.