After a strong rally this year, banking stocks have lost some of their luster in recent days.
The , which had risen about 40% until mid-June, has now fallen more than 10% from that level. Losses in the group were led by some of the largest lenders in the US, with Citigroup (NYSE:) falling 14% and Regions Financial (NYSE:) collapsing 17%.
So, what is behind this sudden change in the financial sector by investors?
It is perhaps a threat that upcoming gains may disappoint after surprisingly strong performances during the pandemic.
JPMorgan Chase (NYSE:) Chief Executive Officer Jamie Dimon warned investors last week that the lender's trading income, one of the largest during the pandemic, could fall 38% from a year ago to less than $6 billion in the U.S. second quarter. That number could be lower than the already lowered average analyst estimate of $6.5 billion.
Shares of Citigroup also fell the most in five months on June 16 after the bank warned its charges would rise sharply as it invests to comply with a few regulatory clearance orders. Second quarter spending is likely to rise to "somewhere in the middle" from a range of $11.2 billion to $11.6 billion, Chief Financial Officer Mark Mason told investors at a virtual conference. That compares to the cost of $10.4 billion per year.
Weekly chart from Citigroup.
Potched credit
US bank stocks broadly outperformed the benchmark this year, on optimism that higher trading volumes, the reopening of the economy and consumer spending will continue to boost revenues . Some of these assessments are still valid in our opinion.
For example, there remains a huge pent-up demand for credit that was hammered during the pandemic. From individual borrowers to large corporations, 2020 was the year when spending plans were scrapped as lockdowns forced would-be borrowers to save cash and cut costs.
This situation is unlikely to continue as the US economy fully reopens this year as planned. Coupled with massive government spending on infrastructure and a gradual phasing out of monetary stimulus, banks could see a significant increase in credit demand through the remainder of 2021.
Gerard Cassidy of RBC Capital Markets said in a Bloomberg report that bank stocks are a bargain on weakness as credit growth will come after companies and individuals use up the liquidity built up during the pandemic.
In addition, credit quality is strong and margins may improve next year as short-term interest rates rise. "Combine that with increased credit growth, the picture of revenue growth could be very positive for banks in 2022," he said.
Another reason that makes some lenders attractive in this low interest rate environment is the possibility that they can accelerate their share buyback plans and increase dividends after the , which the regulator will publish the results on June 24.
The test examines how large bank portfolios would perform in a hypothetical economic downturn. America's largest banks — a group that includes JPMorgan and Goldman Sachs (NYSE:) as well as Bank of America (NYSE:) — must perform well on the tests before they can return money to shareholders. Analysts are confident that the banks will have no problem passing.
Weekly chart from Bank Of America.
Starting point
The economic backdrop is still favorable for banks, making their stocks attractive after the recent sell-off. Investors who want some banking exposure should consider adding solid names like JPM and Bank of America to their portfolios. These top lenders, thanks to their diversified business models, are in a better position to outperform smaller regional players.
