Downturn, Then Rally Predicted for Bank Stocks

Bank stocks are expected to slump in the wake of last week's interest rate hike and rally later in the year when rate fears subside.

Analysts said investors can be expected to react to the news by pulling their money out of the sector. But they say investors will regain confidence after a few months, when banks' reduced sensitivity to rates is reflected in earnings.

The length and depth of the downturn will depend on whether investors think additional rate hikes are in store, analysts said.

"If history is any guide, it will be difficult for financial stocks to do well in an environment preoccupied by interest rates between now and May," said analyst Raphael Soifer of Brown Brothers Harriman.

Mr. Soifer downgraded shares of BankAmerica Corp., Citicorp, Chase Manhattan Bank, and J.P. Morgan & Co. to short-term "hold" from "buy," after the Federal Reserve hiked the Federal Funds target rate by 25 basis points on Tuesday.

At the same time, however, he upgraded his long-term view on the shares of BankAmerica, Citicorp, and Chase to "outperform," from "market perform."

"Investors are convinced that when interest rates go up, bank stocks go down," Mr. Soifer said. " But bank earnings are not sensitive to interest rates, they are economically sensitive.

"We're just extending the time horizon for the banks," Mr. Soifer said. "After the market digests the rate outlook, investors will again begin to focus on the fundamentals," and their value will eventually be realized, he said.

But as long as it remains unclear whether additional rate hikes are in store, Mr. Soifer said, "the market will stay focused on interest rates."

Indeed, investors appear to have yanked their money out of the sector in anticipation of more rate hikes to come. By midday Thursday, the S&P Bank index had lost 1.75% from last Monday's close.

Morgan Stanley analyst Arthur Soter, who maintained his "buy" ratings on the money-centers, said the slump could be shorter than after previous rate hikes.

"If this is a preemptive strike against inflation, then we could be out of the woods fairly soon," Mr. Soter said. "But if the Fed is just trying to catch up, and we'll have more tightenings, that makes me more nervous because it implies a greater cost in terms of economic growth."

Douglas Cliggot, a market strategist for J.P. Morgan Securities, plans to stick with banks.

"Though the big banking stocks may be neutral or fairly lackluster performers in the near term, we continue to believe that the market multiples for the money-centers and the superregionals will continue to trend up with the market as a whole," Mr. Cliggot said.

"It could be a bit bumpy, but if you do get a patch of significant weakness, then it would be a good buying opportunity," Mr. Cliggot said.

Blaine Rollins, a portfolio manager at Janus Funds, said he is "not stressed at all" by the rate hike. "Interest rates are not going to come in and wallop earnings like they did three or four years ago."

Mr. Rollins said he has been adding to his bank positions in expectation of earnings growth between 15% and 20% for major players. "We're still running with the big horses," he said.

"The worst thing for bank stock investors would still be a recession," Mr. Rollins said. "But as industrial companies are showing double-digit growth, I feel better about that."

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER