Like most of Wall Street, banking stocks took it on the chin in 2022. The KBW Nasdaq Bank Index, which tracks the stock performance of 24 large U.S. national money centers, regional banks and thrift institutions, fell 23.7% in 2022. The index even trailed the S&P 500, which dropped nearly 20%.
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While the sector has recovered a bit in 2023, investors may still see an opportunity to buy bank stocks at a discount. However, Morningstar recently explored the reasons investors may want to reconsider banking stocks as the threat of recession hangs over the industry.
“Adding to the unknowns of a recession, bank stocks face concerns about competition for customer deposits, rising expenses, and a weaker outlook for fees – all of which could damp the profit picture,” Morningstar’s Jakir Hossain wrote in his piece, “Why Bank Stocks Might Not Be a Good Buy Right Now.”
Why You Should Hold Off Buying Bank Stocks
The KBW Nasdaq Bank Index is up nearly 11% year to date, as the banking industry is showing signs of life in 2023. But Morningstar points out that the tailwinds that have helped propel banking stocks may be short-lived. Here’s why you may want to hold off on investing in banking stocks:
Lower Net Interest Margins
While banks make some of their money by charging interest on loans, they also pay interest to customers who keep their money with them. The difference between these two figures contributes to what’s known as the net interest margin. The higher the margin, the higher the bank’s net profits.
When interest rates rise – as they have over the last year – banks stand to make more money on loans. But Morningstar strategist Eric Compton notes in the article that banks benefit most early during a rate hike cycle. Eventually, they start paying higher interest rates on deposits, which eats into their profits.
Carl White, senior president of the supervision, credit and learning division of the Federal Reserve Bank of St. Louis, offered a similar perspective in a recent piece.
“While rising interest rates give banks opportunities to increase earnings by pushing up rates charged on loans, they also could increase the cost of liabilities and decrease the value of investment securities held as assets,” White wrote on the St. Louis Fed’s website.
Higher interest rates on deposit accounts also mean more competition between banks. As a result, net interest margins will “likely be under increased pressure” going forward, Morningstar points out.
Higher Valuations But Lower Revenue?
Compton also noted in the Morningstar article that bank stocks may fall even further. Despite currently trading 11% below average fair value estimates, Compton said investors may want to avoid banking stocks until they reach 25% to 30% below fair value estimates, which typically occurs in a recession.
Meanwhile, banks have also seen a decline in fee revenues, including those assessed to wealth management clients, according to the Morningstar report. Revenue from fees should bounce back eventually, but that may not happen until 2024.
The Bottom Line
2022 was a tough year for investors, especially those who were heavily invested in the banking sector. While the industry has posted better returns so far in 2023, Morningstar noted in a recent piece there are plenty of forces at play that should give investors pause about buying banking stocks in the near term. Those include shrinking net interest margins, slumping fee revenues and valuations that may fall even more if the economy slides into recession.
Tips for Investing During a Recession
When a recession hits, consider having core sector stocks like healthcare, utilities and consumer goods in your portfolio. These sectors are said to be non-cyclical, meaning they don’t rise and fall with the market cycles. Instead, they’re responsible for products and services that people consistently rely upon.
Sometimes it’s best to turn to a professional. A financial advisor can help you make investment decisions so your portfolio can weather an economic downturn. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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