Investors continued their flight from bank stocks Monday, worried that a Federal Reserve hike in interest rates may be imminent.
For the second successive trading day, bank stocks were walloped in reaction to an unexpected jump in April's consumer price index.
The Standard & Poor's bank stock index dropped 1.49%, to 695.18, while the Dow Jones industrial average lost 0.55%, to 10,853.47.
"Investors tend to shoot first and ask questions later," said industry analyst Thomas F. Theurkauf of Keefe, Bruyette & Woods Inc. "Unfortunately, that's the kind of psychology we are burdened with right now."
With the Federal Reserve's Open Market Committee meeting today in Washington, rumors swirled through the investment community that the central bank will adopt a "tightening bias" in monetary policy that signals higher rates ahead - or even skip the preliminaries and raise short-term rates.
"It looks to me it's better than a fifty-fifty probability that the Fed would adopt a bias toward tightening," said Jonathan E. Gray, an analyst at Sanford Bernstein. "We are late in the business cycle. The labor markets are sold out in terms of the employment situation. Anyone who can walk has a job."
The market for Treasuries reflected a nervousness that the Fed may do something today, observers said.
Treasury notes fell, with 10-year yields rising 2 basis points, to 5.64%. Yields on 30-year Treasuries fell 2 basis points, to 5.89%, but still are flirting with the 6% barrier.
Within the financial services sector, mortgage lenders are seen as particularly vulnerable because of rate sensitivity.
Mr. Gray downgraded stocks of three major West Coast thrifts to "market perform" from "outperform." Washington Mutual Inc. of Seattle fell 3.42% to $38.875; Golden State Bancorp. of Glendale, Calif., 4.62% to $24.50; and Golden West Financial Corp. of Oakland, Calif., 0.49% to $101.0625.
If the Fed does not move toward higher rates, Mr. Gray said, thrifts stand to gain from steepening of the yield curve. The curve-an imaginary line across maturities of government securities-steepens when longer-term yields rise in relation to shorter-term yields.
But Mr. Gray said it seems likely that the Fed will ultimately raise rates unless the economy's growth rate slows, the labor shortage mitigates, and evidence appears that inflation is not on the rise.
"This is going to keep the cloud over the financial sector at least for the short term until rates start coming back down," said David Allaire, co- portfolio manager of the Imperial Bank Fund of Providence, R.I.
Still, a few banks bucked Monday's trend. Bank of America Corp. held steady at $68.5625. Commerce Bancshares rose 0.68% to $41.53125, and Bankers Trust Corp. was up 0.14%, to $91.625.
While bank stocks' price-to-earnings ratios significantly trail those of the Standard & Poor's 500 index, they are still vulnerable, Mr. Allaire said.
Among the more highly valued bank issues, State Street Financial Corp., with a price-earnings multiple of 30.1 at the market's close on Friday, fell 5.95%, to $79 on Monday. Citigroup, with a 28 multiple, fell 1.41% to $70.
Still, on a relative basis, the rise in interest rates will make banks stocks a better buy, Mr. Allaire said.
With Treasury bond rates rising, "the valuations are compelling," Mr. Allaire said.