Bank stocks fell precipitously Wednesday as conventional thinking about banks and interest rates took hold.
After rallying on Tuesday when the Federal Reserve announced a 25-basis-point hike in short-term rates, on Wednesday the American Banker index of 50 banks fell 2.53%, the American Banker 225, 2.99%, and the American Banker thrift index,1.44%.
Losing stocks included Chase Manhattan Corp., which was down $4.125, or 4.8%, to $81.875; Cleveland-based National City Corp. $1.875, or 6.49%, to $27; and J.P. Morgan & Co. $2.50, or 1.76%, to $139.75.
Analysts who had attributed the Tuesday rally to the belief that the Federal Reserve was done raising interest rates -- particularly since it shifted its bias to neutral from tightening -- said investors were having second thoughts. "Just because the Federal Reserve has moved to neutral does not preclude them from raising rates in the future," said analyst Marni Pont O'Doherty, a bank analyst at Keefe, Bruyette & Woods Inc.
Investors concluded "that this was the last increase from the Fed at least for the next three or four months, if not for the cycle," said Thomas F. Carpenter, chief economist at ASB Capital Management in Washington. Bank stocks sank again because investors realized that "that there was no significance in the Federal Reserve moving its bias to neutral from tightening. Historically, they have always done that after they raise interest rates."
Lawrence W. Cohn, an analyst at Ryan, Beck & Co. in Livingston, N.J., said, "The Fed has signaled quite clearly its intention to put pressure on rates if the economy continues to grow at the rate that it is growing. Investors were hoping that this past hike was the last one, but they realize it may not be and so are focusing on the next one."
In the last month, short-term rates have risen while long-term rates declined, making it more difficult for banks to make money from lending.
Some argue that today's banks are protected by hedging strategies and greater reliance on fee income, which is less vulnerable to rising interest rates. But National City Corp. -- one of few banks to lose ground both Tuesday and Wednesday -- said Tuesday that it would miss its fourth-quarter earnings targets because of the compression on its margin on loans.
Mr. Cohn said that bank stock investors are in a Catch-22: If the economy weakens it hurts bank customers' ability to repay loans, and if becomes too strong, it is bad for banks because it could lead to higher rates, said Mr. Cohn. "Investors are pulled between moments of euphoria and worrying about the longer term outlook of banks."
Mr. Cohn also warned that it is "not reasonable" for investors to think banks can continue to churn out double-digit growth. "In an economy that grows 3% or 4% in real terms and 5% to 7% in nominal terms, one cannot expect banks to make 50 to 100% more over a extended period," said Mr. Cohn. "It is time for bank earnings to come back to the mean, which is single-digit revenue growth."
Also in trading Wednesday, shares of Charter One Financial gained 25 cents, or 1.02%, to $24.8125, on news that the Cleveland thrift company has applied to list its stock on the New York Stock Exchange starting Dec. 6.