Federal Reserve rate cuts typically have been a boon for bank stocks. It is less certain that will be the case this time around.
The Federal Reserve is widely expected to cut rates at its meeting Wednesday, after pausing its rate increases earlier this year.
That followed the Fed slowly raising rates to between 2.25% and 2.5% by the end of last year, up from between 0.25% to 0.5% in 2015.
The Fed’s change of heart has already bolstered the market, and bank stocks. As of Tuesday’s close, the S&P 500 is up 20.2% year to date, while the Nasdaq Bank index is up 15.5%.
And based on bank-stock performance during periods of monetary easing, investors could potentially expect more gains. Going back three decades, the Nasdaq Bank Index has outperformed the S&P 500 four of the five times the Federal Reserve has lowered interest rates, according to a Stephens Inc. data analysis.
While lower rates can cut into bank profitability, that is often outweighed by the economic expansions that accompany Fed rate-cutting.
This time around, there are some important caveats. For starters, interest rates are already at superlow levels. In 2001, when the Fed began lowering rates, the starting point was 6.5%. A decade earlier an easing campaign began when rates were around 8%.
So the Fed’s move Wednesday might not pack as much punch, either in terms of spurring growth or a lending fillip. Unemployment, for example, is already at historically low levels, not on the rise. Plus, the Fed’s move may be partly in reaction to negative yields in other countries.
Meanwhile, the yield curve, or the difference between short- and long-term rates, has been inverted a handful of times this year. That hurts bank profitability. A steeper curve—or when there is a starker difference between long-term and short-term rates—would be an impetus for bank stocks to outperform, said Aaron Clark, portfolio manager for GW&K Investment Management. “I don’t see that happening,” he added.
Mr. Clark said bank stocks could perform more like utility stocks, yielding low growth and lower returns on equity. His expectation: They won’t outperform significantly.
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