- The KBW Bank Index is now down around 20% this year as the risk of recession increases.
- Despite the economic uncertainties, this time around it is difficult to establish a definitive selling point for lenders.
- Banks are in much better shape than in the last recession.
Fear of a deep recession is driving investors away from the banking sector, which was the best performing market segment last year.
This year it fell by around 20% as the risk of a prolonged recession increases due to stubbornly high inflation forcing the central bank to keep raising interest rates.
KBW W1 bank index
The group’s losses were led by some of the largest lenders in the United States, with JPMorgan & Chase (NYSE 🙂 falling 27% this year and Citigroup (NYSE 🙂 18%.
The sale of bank shares comes as these companies announced better-than-expected earnings during the earnings season that has just ended. These lenders have seen strong increases in revenue and loan margins, which had suffered from historically low borrowing costs for years.
Net interest income, meaning interest-bearing income minus cash paid to depositors, has increased the profitability of JPM, Morgan Stanley (NYSE :), Citigroup and Wells Fargo & Co. (NYSE :), and some have even improved their forecasts for the rest of the year.
But despite the windfall from interest income, other economic headwinds are accelerating and could hurt banks’ profits. Most importantly, a potential slowdown in credit demand at a time when consumers are hit by inflation which is at its highest level in four decades.
The group’s earnings could be hurt by slowing loan growth, narrowing spreads between 2-year (NASDAQ 🙂 and 10-year (NASDAQ) treasury bills and rising defaults. In the coming months, banks could show the impact of “demand destruction due to inflation” among US customers who have held up well so far, according to a note from the Bank of America.
While some stocks may have bottomed out in a mild recession scenario, the risk of a deeper recession will likely continue to weigh on the group. According to the Bank of America note:
“Investor sentiment at the end of the cycle will be difficult to dispel and is likely to weigh on valuation multiples. A deeper recession and / or more persistent inflation remain the main risks.”
Hard landing of the US economy?
The risk of a hard landing for the US economy has increased after Fed Chairman Jerome Powell told the annual meeting of monetary policymakers last week that the way forward will “hurt families and businesses” in the United States. , an “unfortunate cost to lower inflation.”
Another setback that makes bank stocks less attractive in this environment is their reluctance to pursue their stock buyback plans when navigation gets tough.
Both Citi and JPMorgan announced last month that they would suspend their share purchases to meet higher capital requirements.
Despite economic uncertainties, bank stocks will not suffer as much as they did during the 2008 financial crisis, and their weakness offers a buying opportunity for long-term investors.
First, banks are in much better shape than they were in the last recession, thanks to a much stricter regulatory regime, better underwriting standards and capital levels that have nearly doubled since the 2008 crisis.
Second, there is a good chance that if the recession comes it will be swift and superficial, with the labor market continuing to show signs of strength. In this scenario, banks will avoid the kind of blow to loan growth the market anticipates and could recover quickly.
On a recent note, Oppenheimer analyst Chris Kotowski said the entire industry is too cheap after the 2022 sell-off, explaining:
“Indeed, the numbers of banks with very strong loan growth and rising interest rates still indicate a very robust economy. Perhaps lower spending on some goods, but spending on services, travel and leisure seems robust.” .
“We believe that when the next recession arrives, the quality of the banks’ assets will remain much better than widely feared and the group will return to historical levels.”
Bottom Line: Banking Shares, A Good Bet On The Stock Market Now?
Bank stocks are likely to remain depressed in the current uncertain economic environment. For long-term investors, however, this weakness represents a buying opportunity as banks are expected to rebound strongly once the recession ends.
Disclaimer: The author does not own any shares of the companies mentioned in this article.