Banks have long been a favored industry group among top-performing newsletters, according to my auditing firm’s monitoring. This popularity often indicated an expectation of rising interest rates, as conventional wisdom suggests that higher rates lead to increased bank profits. However, the reality in recent years has proven to be quite different.
Contrary to expectations, higher interest rates have actually hindered bank profits just as much as they have helped. This surprising trend is evident in the following chart, which depicts the trailing 10-year correlation coefficient between bank stocks’ performance and interest-rate changes. A high coefficient would support the conventional wisdom, while a coefficient close to zero suggests that higher rates have no discernible impact on bank stock returns. Notably, there has been a noticeable decline in this coefficient in recent years.
Various factors have contributed to this significant shift in correlation. Chief among them is the increasing proportion of banks’ investments in U.S. Treasury bonds. These bonds, despite being considered a safe haven, have suffered greatly as interest rates have risen. The surge in banks’ exposure to Treasurys was primarily driven by regulatory requirements enforced after the global financial crisis, which mandated the augmentation of loan loss reserves. After all, what investment could be safer than U.S. Treasurys?
It is crucial for investors and financial experts to recognize this evolving landscape of bank profits. The once-reliable assumption that higher interest rates equate to higher bank profits can no longer be taken for granted. As we navigate this new reality, a deeper understanding of the complex interactions between interest rates and bank stocks becomes essential. Only then can we make informed decisions that align with the ever-changing dynamics of the banking industry.
Bank Stocks and the Factors to Consider
When it comes to evaluating bank stocks, it’s important to understand that the interest rate trend is not the sole determinant of their performance. The profits banks earn from the higher margins between deposit and loan rates can be offset by losses on their bondholdings, and vice versa.
One key factor to consider is the belief in a soft landing, whereby the Federal Reserve successfully cools down the economy without causing a severe recession. While this topic is widely debated on Wall Street, it is noteworthy that newsletters with impeccable track records are betting on the Fed’s success.
Additionally, many newsletters recommend bank stocks due to their healthy dividend yield. The average yield of the top-performing newsletters’ current favorite bank stocks listed below is 4.1%. This yield is comparable to the current 10-year Treasury yield of 4.3%, but these bank stocks have the advantage of significant growth potential. Even if these stocks were to underperform over the next decade, they are still likely to outperform 10-year Treasurys.
Table: Current Top Bank Stocks
- Bank Stock A
- Bank Stock B
- Bank Stock C
- Bank Stock D
- Bank Stock E
- Bank Stock F
- Bank Stock G
In conclusion, thorough consideration should be given to factors beyond the interest rate trend when making bet on bank stocks. A soft landing scenario and the healthy dividend yield offered by these stocks make them an enticing investment opportunity.