Wall St Week Ahead-U.S. bank stocks falter as recession worries take hold

The S&P 500 banks index has slumped some 11% this month against a 5.5% drop for the broader index in the same period. Among the hardest hit were shares of Bank of America, which have fallen 16% this month. Shares of Wells Fargo & Co have slumped about 14%, and those of JPMorgan Chase & Co are down over 6%.

Signs of pessimism over the economy have crept into asset prices in recent weeks, as investors grow increasingly worried that the Federal Reserve’s most aggressive monetary policy tightening in 40 years – aimed at reducing inflation – will also hamstring growth

Treasury yields, which move inversely to prices, have recently tumbled to three-month lows, signaling that growth worries may be pushing investors into bonds. Others have pointed to energy shares, which have fallen about 12% from recent highs, as a sign that investors may be factoring in an economic slowdown.

Banks face a potential double whammy: While a recession could hurt loan growth and increase credit losses, higher rates threaten to shrink profit margins if the interest that lenders pay out on deposits eats away at interest earned from loans.

Job cuts have further hinted at the stresses banks expect to face: Goldman Sachs is planning to cut thousands of employees to navigate a difficult economic environment, a source familiar with the matter told Reuters on Friday, the latest global bank to reduce its workforce in recent months.

“Bank stocks do not do well in a recession, and more and more investors are worried about a hard landing,” said Matt Maley, chief market strategist at Miller Tabak.

While bank stocks have traded broadly in line with the S&P 500 throughout the year, their decline accelerated in recent weeks, with the S&P 500 bank index now off over 24% in 2022. The S&P 500 is down 19% year-to-date, on pace for its biggest annual percentage drop since 2008.

“The recent performance of banks is evidence to me that there is increased concern around the economic outlook for 2023,” said Walter Todd, chief investment officer of Greenwood Capital. Expectations of a slowdown led Todd’s firm to sell some of its bank shares earlier this year.

Profit margins are one potential trouble spot investors are focusing on. Higher rates led net interest margins — which measure how much a bank earns on loans and fixed income securities compared with what it pays out on deposits — in the third quarter to expand to their widest average spread in three years, among 20 banks tracked by RBC Capital Markets.

RBC Capital Markets analyst Gerard Cassidy said part of the recent weakness in bank stocks reflects expectations that net interest margins will peak next year and concerns that “we are going to see increases in the provision for credit losses due to the expectation of a slowing economy in 2023.”

The extent of such pressure will become clearer next month when banks report fourth-quarter earnings. In another potential stumbling block for the group, some of the banks that lent Elon Musk $13 billion to buy Twitter are preparing to book losses on the loans this quarter, Reuters reported this week.

Investors will learn more about the economy’s health next week, with data due on housing and consumer confidence.

Of course, banks’ discounted shares may prove alluring for investors who believe the economy will remain on stable footing.

The S&P 500 banks index trades at about nine times forward earnings estimates, below its long-term average P/E of 12 times and well lower than the roughly 17 times for the overall S&P 500, according to Refinitiv Datastream.

King Lip, chief strategist at Baker Avenue Wealth Management, said his firm recently bought bank stocks, convinced that any hit to U.S. growth will likely be moderate.

“Our take is that the economy should be able to avoid a significant recession in 2023 …,” Lip said. “This should improve investor sentiment in banks.”