Recession talk is in the air but that hasn’t taken the steam out of bank stocks this year, and the sector may have further to climb–thanks to the Federal Reserve.
On Wednesday the Fed lifted the target range for the federal-funds rate by a quarter of a percentage point to a range of 4.5% to 4.75%. Even though the Fed warned that “ongoing” hikes would be necessary to get inflation down, the current increase puts the fed-funds rate even closer to its so-called “terminal rate” of roughly 5.1%, at which point the Fed will stop hiking.
The end of a tightening cycle has historically been a time when bank stocks have outperformed, according to analysis by Gerard Cassidy, analyst at RBC Capital Markets.
The only thing that could trip up a bank stock rally would be a deterioration of the banks’ credit portfolios, as was witnessed in the 2008-09 financial crisis. But there’s less reason to worry these days.
First, unlike in prior economic cycles, banks are now required to book anticipated losses on loans before they materialize–if they ever do. This accounting mechanism can make bank earnings appear weaker in good times but it allows them to be prepared for when things truly head south.
Second, even if the economy tips toward a recession, bank customers, many of whom are still sitting on pandemic stimulus cash, are entering a downturn in a stronger position. What’s more, while many still believe a recession is possible in 2023, many believe that it will be “mild,” according to the favored term used by bank executives on earnings calls last month.
All of this adds up to “manageable” risks for banks, according to Cassidy.
Even so, Wall Street has been cautious about banks. Last year was supposed to be a good one for banks as the Fed aggressively raised interest rates, allowing banks to earn more interest on the loans they issue. But rather than rejoice, investors were more worried about the risk of a recession. The
SPDR S&P Bank ETF
(ticker: KBE) fell 17.3% last year, faring only slightly better than the
which was down 18.4%.
But sentiment is changing, as witnessed by the 9.5% climb in the KBE this year–a climb that is likely to continue.
“The sentiment on bank stocks is very cautious-to-bearish, in our view. As a result, as investors start to see a more moderate credit cycle than in 2008-2009, while at the same time witnessing the benefit of a Federal Funds rate between 5.00-5.50% that will drive net interest income growth, we believe more of them will move to own the bank stocks,” Cassidy wrote.
Cassidy is a fan of large and regional banks with strong deposit bases. Some of the names that meet his criteria are
Bank of America
The KBE advanced 1.3% in Wednesday’s trading.