Despite the improvement in domestic economy, higher interest rates, tax cuts and the growing optimism regarding lesser regulations, the performance of bank stocks during the first half of 2018 has not been as impressive as expected.
Though the first-half performance of banks can be assessed only after the release of second-quarter 2018 results, several macroeconomic headwinds have been hurting the price performance of the industry.
During the first half of 2018, the KBW Nasdaq Bank Index declined nearly 2.6% and the S&P Banks Select Industry Index witnessed a marginal drop. These compare unfavorably with 1.7% growth of the S&P 500 index.
Some of the factors that weighed on investors’ sentiments and possibly led to the dismal performance include the uncertainty relating to the U.S.-China trade war, reduced market volatility (specifically in May and June) and the recent flattening of the yield curve.
Is the grim price trend likely to persist in the near term?
Let’s take a look at some of the factors that are likely to affect the performance of banking stocks during the second half of 2018.
Interest Rates: Given the expectation of two more rate hikes in 2018, banks are likely to record higher interest income, the primary source of revenues. However, if the current scenario with respect to the slope of the yield curve remains intact, the benefit of higher rates will get neutralized to some extent. This is because along with higher rates, a steep yield curve is required for interest income to rise. But since the yield curve is currently toward the flatter side, higher rates will not be enough to support revenue growth for banks.
Trade War: If there is a full-blown trade war between the United States and China, business investments will gradually slow down, leading to a decline in the pace of economic growth. And since the performance of bank stocks is mainly tied to the country’s economy, they are expected to bear the brunt of the same.
In fact, with the imposition of U.S. tariffs on nearly $34 billion worth of Chinese goods, the signs of a trade war are apparent. Thanks to such tariffs, the rate of unemployment may rise in the future, which will also impede economic growth, thereby indirectly hurting banks’ performance.
Notably, if economic growth slows down, it might force the Fed to rethink its plan of rate hikes. The timing as well as the amount of rate hikes may be negatively impacted. Also, with a decline in business investments, the demand for loans may decrease. Thus, a slowdown in the pace of rate hikes combined with lower loan demand is expected to pose a major threat to banks.
Digitalization: Banks are of late focusing on digitization of operations, which reflects a customer-friendly move. Banks have been undertaking efforts to align their network according to clients’ needs and upgrading ATMs with latest technology. These initiatives are expected to result in more customer engagement at a lower cost, thereby boosting performance as well as profitability to some extent.
Tax Rates: With the enactment of the Tax Cuts & Jobs Act, banks are positioned to benefit from lower tax expenses. Particularly, the new tax legislation will cut effective tax rates for some of the big names in the industry such as JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC).
Moreover, because of lower taxes, companies will have more cash available with them that can be used for growth purposes. With the free cash available, they can engage in buybacks, pay more dividends and also carry out mergers and acquisitions. With the increase in M&As, the related fees will rise thereby boosting revenues for banks’ investment banking divisions.
Regulations: For long, there has been growing investor optimism regarding lesser regulations as indicated by Trump. Now, with the passage of the Economic Growth, Regulatory Reform, and Consumer Protection Act, all banks, particularly the smaller ones are expected to gain significantly. The bill, aimed at lessening stringent regulations, will likely lower compliance costs and support banks’ financials.
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