Why bank stocks are the ‘Achilles’ heel’ of markets as bears worry high bond yields may ‘break’ something

Bank stocks are in need of a “recovery rally” to show that higher interest rates won’t necessarily doom the U.S. economy to a recession in 2024, according to DataTrek Research.

“U.S. bank stocks are the market’s Achilles’ heel just now,” said Nicholas Colas, co-founder of DataTrek, in a note emailed Thursday. “If the bears are right and ‘something is going to break’ because of suddenly higher interest rates, then that ‘something’ will almost certainly involve U.S. banks.”

Shares of the SPDR S&P Regional Banking ETF
have plunged around 30% this year through Thursday, while the SPDR S&P Bank ETF
tumbled almost 20% over the same period, FactSet data show. Both funds have dropped nearly 2% so far this month, exceeding the S&P 500’s decline of almost 1% during the same stretch.

“At least U.S. bank stocks are not making new 52-week lows even as rates spike, but their recent momentum is pointing in the wrong direction,” said Colas. “Sentiment on this group is terrible, with dividend yields on most S&P 500 bank stocks signaling meaningful declines in earnings power over the next 12 months.”

The Federal Reserve’s rapid rate hikes to battle inflation led to stress this year for regional banks. In March, Silicon Valley Bank failed suddenly and the Fed announced an emergency lending program for banks to help ensure they could meet the needs of their depositors.

The recent surge in bond yields as investors appeared to adjust to the notion of higher for longer rates has renewed concerns over banks. 

“If higher yields hit the value of a bank’s bond portfolio, it may need to raise more capital or sell at a distressed price,” said Colas. “If higher yields cause a recession, then loan losses will rise.”

The yield on the 10-year Treasury note
has surged in 2023, but slipped on Thursday to 4.715%, according to Dow Jones Market Data. That’s after earlier this week climbing to its highest level since August 2007 based on 3 p.m. Eastern Time levels.

Mired in losses, the SPDR S&P Regional Banking ETF and SPDR S&P Bank ETF each closed sharply higher Thursday, FactSet data show. Shares of the regional banking fund climbed 1.7% while the SPDR S&P Bank ETF rose 1.6%.

Beaten down U.S. bank stocks may be attracting bullish investors.

“If you are very bullish here, this is the group for you,” said Colas. For its part, DatraTrek leans “more to the cautious side on banks right now.”

When an individual stock’s dividend yield triples that of the S&P 500, which is now at 1.6%, then “as a rule of thumb,” said Colas, “you know the market is saying a dividend cut is coming and earnings power is significantly below what management and their board thinks it is.”

According to DataTrek, the market “rightly or wrongly” believes 11 of the 17 banks in the S&P 500 index may have to significantly cut their dividends, likely over the next six to 12 months. Colas prefers “to wait until Fed rate cuts are close at hand and dividend cuts have started.”

Meanwhile, the U.S. stock market finished slightly lower Thursday, as investors digested data showing initial jobless claims rose slightly less than expected in a still strong labor market. The Dow Jones Industrial Average
dipped less than 0.1%, while the S&P 500
and Nasdaq Composite
each fell 0.1%.

The S&P 500 remains up 10.9% this year through Thursday, after the index logged losses in September and August amid worries over higher rates.

Why bank stocks are the ‘Achilles’ heel’ of markets as bears worry high bond yields may ‘break’ something

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