Bank stocks are generally rallying Monday following good earnings reports over the past two sessions from Bank of America (BAC) , JPMorgan Chase (JPM) and other names, but longer-term weakness still makes the sector a good buy.
You can either purchase an exchange-traded fund like the Financial Select Sector SPDR ETF (XLF) or go for some of the big money-center banks like JPMorgan, Citigroup (C) or Wells Fargo (WFC) . Regional banks like U.S. Bancorp (USB) , PNC Financial Services Group (PNC) , BB&T Corp. (BBT) , SunTrust Banks (STI) and Regions Financial Corp. (RF) should also do well. In fact, they might even have a bit more room for aggressive growth to their underlying businesses than the big banks do.
Here's why I like banks here:
They Passed Serious Stress Tests
As those of you who follow my writing know, I'm more than happy to poke a stick at the establishment when necessary, but banks' passing marks on the latest U.S. and foreign "stress tests" should give investors plenty of comfort.
It's true that some early bank stress tests done shortly after the 2008 financial crisis were designed to be easily passed so as to mollify investors (especially European-bank investors).
However, this year's tests - which most banks passed in recent weeks - were different. They were not only incredibly tough, but my sources tell me that regulators designed the tests to limit any loopholes or easy solutions. For example, banks didn't know ahead of time which day regulators would choose for the stress tests, so firms couldn't position any short-term trades that would help them pass muster.
Frankly, banks are simply in a far better position today than they were before the 2008 financial crisis. Firm have improved both their asset quality and how they manage their own funding needs.
The Flattening Yield Curve Isn't a Big Deal
Pundits like to talk about the spread between 10- and two-year U.S. Treasury yields as though it matters to banks, but the idea that firms "lend long and borrow short" is archaic these days. That's because few if any banks lend long and borrow short any more.
Instead, many banks typically issue floating-rate loans. And even when firms do make fixed-rate loans, they typically use swaps to convert this debt into floating-rate debt. And while banks sometimes make longer-term loans, they really only do so to capture the credit spread. So, what banks care about these days isn't the U.S. Treasury spread, but the London Inter-Bank Offered Rate (or "LIBOR").
In fact, most of the income that firms make is pegged to the LIBOR, which has risen substantially this year. For instance, the three-month LIBOR is 2.34% today vs. 1.7% in January and just 1.4% in November. This means that banks are earning almost 1% more on their loans than they did just three quarters ago.
Now, some people have been concerned about the "beta" of banks' borrowing rates vs. lending rates. At its simplest, this refers to how much of each Federal Reserve rate hike gets passed along to consumers.
But I think that's being too clever by a half. Personally, all that I care is the fact that net interest margins look good -- and will continue to do so as long as the spread between what banks lend and borrow at remains constant or widens.
In fact, all evidence points to the LIBOR rising faster than deposit rates. That's more important for bank net-interest margins that is the 2-year/10-year U.S. Treasury yield spread that so many people focus on.
Loan Demand Remains High
Lastly, it's worth nothing that banking activity remains robust.
On the institutional side, investment-grade bond issuance was higher during 2018's second quarter than it was a year earlier. That's impressive when you realize that companies like Apple (AAPL) and Microsoft (MSFT) benefited from the new overseas-profits-repatriation rule and didn't issue any bonds.
On the retail side, I see anecdotal evidence of increasing activity that's consistent with the upturn that we're seeing U.S. gross domestic product growth.