Financial services, one of the most vulnerable sectors during the pandemic-induced recession, is now roaring back. US bank stocks have significantly outperformed the benchmark this year. Investors have grown optimistic about lenders, believing the worst is over and the economic reopening will spur income growth.
The Index is up about 20% so far this year, while the S&P 500 gained only 5% over the same period. Individual lenders, such as JPMorgan Chase (NYSE :), Goldman Sachs (NYSE 🙂 and Bank of America (NYSE :), have posted double-digit gains thanks to their strong investment banking and trading divisions.
JP Morgan Chase Weekly Chart.
Investors have pushed their stock prices higher, believing that more corporate lending, higher infrastructure and consumer spending, after passing a second stimulus package, will begin a new era for lenders inundated with cheap liquidity.
Goldman Sachs Weekly Chart.
In addition to this optimism is on the rise, indicating that the Federal Reserve will likely be forced to raise interest rates earlier than expected to fend off. Higher rates allow banks to charge more to borrowers, increasing credit margins on products, from credit cards to mortgages.
Bank of America Weekly Chart.
In this very favorable environment, it is a great unknown how far this rally can go after a remarkable turnaround in banking stocks since the plunge in March 2020.
More profit to come
Some analysts believe that these favorable economic conditions – mainly higher bond yields and more stimulus measures – could provide an additional boost to bank stocks, especially as the roll-out of vaccines accelerates.
"These stocks have had a tremendous run since the start of the year," RBC analyst Gerard Cassidy said in a recent Bloomberg report. “If you look at them over the next 12 to 18 months, they are still reaping significant benefit,” he said, drawing attention to good credit trends and aggressive bank lending in preparation for a major credit storm that didn't. materialize.
Referring to bank stocks, Wells Fargo analyst Mike Mayo in a report entitled "What's not to like?" highlighted the successful roll-out of vaccines, the Federal Reserve allowing more share buybacks and the Democrats' victory in the Senate that paved the way for more government stimulus.
While bank stocks look attractive in the long run, is it worth waiting for a downturn to buy back? The latest comments from some of the top bankers suggest that there are still some risks lurking that could thwart this rally. JPMorgan, the largest US lender, warned investors in January that the uncertainty remains, and it was not reducing the money set aside for credit card losses.
Trading in asset markets was another factor that helped banks reverse their pandemic slump rapidly. For example, trading earnings for Goldman Sachs hit its 10-year high in the previous year. JPMorgan generated the most profit and revenue it has ever made from its market unit in one.
That hyperactivity in markets may not help much when the economy opens up again and retail sales decline. Another threat could come from the struggling commercial real estate sector, which has been a major contributor to smaller banks' profits.
Jerome Powell, chairman of the Federal Reserve, told Congress last month that he is closely watching developments in that sector due to the banking system's exposure to commercial real estate. Prices "appear prone to falling sharply, especially as the pace of ailing transactions accelerates or, in the longer term, the pandemic leads to permanent changes in demand," the Fed said in a Feb. 19 report.
Bottom Line
Bank stocks continue to look attractive even after their vigorous run in 2021, while many macro trends remain favorable for their business in the post-pandemic economic recovery. That said, investors who want some bank exposure in their portfolios are better off sticking to solid names like JPM, Goldman Sachs and Bank of America for their diversified portfolios and stronger balance sheets.
