Strong Bank Stocks Could Be Trouble For the S&P

Strong Bank Stocks Could Be Trouble For the S&P

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Last week, some pretty big financial names kicked off another earnings season with some good earnings per share (eps) beats. JP Morgan, Citigroup, Wells Fargo, and PNC all reported and beat the street’s expectations on eps and all but Wells Fargo beat estimates on top-line revenue. All but PNC are represented in the Top 10 of financials by “index weight” in the S&P 500. This week we have Blackrock Inc. reporting today, Goldman Sachs and Bank of America tomorrow, and Morgan Stanley due on Wednesday. Goldman, B of A and Morgan Stanley are also in the S&P top 10 financials by index weight. With the strong earnings we saw Friday and the anticipation of more this week, one would think stocks would have been higher Friday and continue the up momentum this week.

Stocks were indeed higher Friday with the NASDAQ +.61%, the Dow +.39% and the S&P +.47%, with the latter 2 reaching new all-time record highs and record high closes, but the financial sector did not lead. The financials  was the only negative sector on Friday turning in a -.52% performance Friday. When you break the sector down, you see the the weakest performer within the sector was the banks (-.97%). But didn’t they beat estimates?

 

There is always more than one ingredient in a stew. Banks turned in good numbers and went down, while the US economy turned in some pretty poor number and overall markets went up. The backdrop of interest rates are the reason. If you ever wondered if low rates were truly the reason for the bull market, Friday was practically a step-by-step on why the answer is yes.

The US missed on the CPI estimates, retails sales were negative (they were expected positive) and industrial production beat on the headline but the prior month was revised down. This caused markets the think the Fed would not only stay on a less aggressive path of rate hikes and balance sheet normalization, but might have to stop entirely. This is the 5th month in a row that year over year CPI in the US has fallen since reaching 2.27% in Jan ’17. 10 year note yields fell as low as 2.279% before closing back slightly higher at  2.319%.

So back to banks; higher 10 year yields, with a stable-to-slowly rising Fed funds rate means a steep yield curve and more profits in bank lending. Loans are the source of the banks “easy money”, so if the easy money trend is slowing, then banks will have to take more risk to hit their numbers. On the contrary, the low rates by the Fed are the source of other industry’s easy money so if he Fed has to pause, then stocks in everything (except maybe) banks go higher.

There’s more to it than just this, but the simple answer is bank stocks correlate very highly to bond yields, so if rates rise, banks stocks rise. If the rise too fast, the S&P falls.

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