As rising long-term interest rates continue to pummel most equities, it may be time to pivot into bank stocks.
Yields on 10-year Treasury notes hit 3.24% Friday, sending stocks into another tailspin following Thursday's slide. The Dow Jones Industrial Average I:DJA fell more than 300 points, or 1.2%, by early Friday afternoon. The S&P 500 undefined was also down more than 1%.
"The market looks exhausted right now," John Toohey, head of equities at USAA told TheStreet. There's "some unwinding that's going on."
Whether or not the U.S. market is in for a sustained downturn, and whether or not a recession is coming soon, investors may be wise to look at bank stocks when seeking value. "I would agree with the statement that they're starting to look undervalued," Toohey said.
U.S. banks have underperformed the market by 14% this year, a team of Goldman Sachs analysts pointed out in a note out to clients. Citigroup Inc. (C) - Get Citigroup Inc. Report is down roughly 2.5% this year. Wells Fargo & Co. (WFC) - Get Wells Fargo & Company Report is down almost 13% this year, with some pressing company specific issues of course. Goldman Sachs Group Inc. (GS) - Get Goldman Sachs Group, Inc. (GS) Report is down almost 12% this year. However, "Large banks experience frequent pullbacks on macro concerns, typically followed by quick recoveries," the Goldman note said.
Goldman pointed out that banks saw selloffs in March and June this year, both of which were related to broad macro economic risks. "Following these episodes, the banks typically recover their peak prices within 90 days of reaching -10% pullbacks, often as macro concerns recede," the analysts wrote. Goldman noted that large banks are trading below their average post financial crisis multiples of 10.7 times earnings. Specifically, Wells Fargo, which has been battered this year, is 'buy' rated by Goldman.
With their falling multiples, bank stocks could be a buy right now. "We believe these valuation levels provide an attractive entry point for the group, particularly as we expect significant operating leverage improvements to materialize in 2019 and 2020," the Goldman note said.
Still, some are hesitant to add to their clients' positions in bank stocks. "I don't know if I would say they're undervalued," Mike Loewengart, vice president of investment strategy at E*Trade told TheStreet.
There have been several headwinds that have hit large-cap banks this year. "A weak loan growth environment combined with a yield curve that's not steep, combine with deposit beta's going up, and now as the Fed raises rates they [banks] are passing some of that through, so that's a headwind," Toohey said.
One major concern is that rising interest rates are expected to hurt loan volumes. Meanwhile, net interest margins may not expand materially, as banks look to pass on cash flows from increased interest rates they're charging borrowers to customer savings accounts. Consumer banking has, in the view of many, become competitive, so banks are competing for depositors so they can continue to be well capitalized and lend.
So for now, Loewengart is advising clients to sit tight and neither reduce nor increase their positions at this point.
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