Don’t count on bank stocks to bail out investors from the rout in tech shares.
While financial companies helped cushion U.S. stock indexes during previous bouts of tech turmoil in recent years, these days the two market segments are moving in tandem. The shift has come about as the spread between shorter- and longer-term borrowing rates narrows, a negative development for bank stocks.
The dynamic was on display in Monday’s markets, when Facebook dragged tech shares lower following reports of a data breach and increased speculation of a regulatory response. Meanwhile, banks were also down as the Treasury curve flattened and strategists at UBS AG and Morgan Stanley predicted the phenomenon will gain strength this week amid forecasts for Federal Reserve policymakers to boost their projections for interest rate hikes over the next two years by more than their longer-term estimates.
The thinking for banks is that inasmuch as financial institutions engage in the business of maturity transformation — borrowing money for a shorter period than they lend money — a narrowing yield spread is going to be a drag on profits. That relationship hasn’t necessarily been borne out when it comes to changes in banks’ net interest margins this cycle, but it is something that investors have often taken their cues from.
The fourth quarter of 2017 was an exception. Banks were among the prime beneficiaries of the overhaul to the U.S. tax code, and bested their peers as the legislation progressed. But in 2018, their relative performance has loosely tracked the yield curve once again.
In fact, the 63-session correlation between the daily change in the KBW Bank Index and Nasdaq 100 Index flipped to negative last year for the first time on record. But not only have banks now reconnected with the yield curve — they are also displaying increased synchronicity with titans of tech: That three-month correlation is now at its most positive level since before the U.S. election.
This return to the old relationship between tech and bank shares is disrupting the key factor driving the low volatility investors enjoyed in 2017: relentless rotation. When tech was struggling, banks were there to help pick up the slack, and vice versa. The shift could portend more market chop in 2018.
