JPMorgan Chase & Co. (JPM) CEO Jamie Dimon's golden age of banking looks more like a blip.
U.S. bank stocks that were supposed to benefit from rising interest rates -- and fatter lending profits -- are instead getting hammered by investor fears of a recession, feeble trading profits and stiff competition for deposits.
On average, the 24 largest U.S. bank stocks are down 17% in the past three months alone, based on trading in an exchange-traded fund that tracks them. JPMorgan, the nation's largest lender, has fallen 12%, while Citigroup Inc. (C) has plunged 19% and Bank of America Corp. (BAC) is down 20%. The broader Standard & Poor's 500 Index is down by just 8.3% over the period.
It wasn't supposed to be this way. In December 2015, when the Federal Reserve started raising interest rates as the economy began to recover from the prior decade's financial crisis, analysts ebulliently touted the ability of banks to jack up the price of loans to households and businesses, while still paying next to nothing on savers' deposits. President Donald Trump's $1.5 trillion of tax cuts gave banks an additional windfall, helping executives like Dimon to increase dividends for shareholders and collect bigger bonuses for themselves.
In June, Dimon boldly proclaimed that the industry was in the midst of a "golden age of banking." But it's not gleaming anymore: The Fed's rate increases have raised borrowing costs so much that many investors now worry about a looming recession, which would be sure to suppress loan growth and usher in a wave of bankruptcies.
Charles Peabody of Portales Partners, one of the few Wall Street analysts to predict the recent downturn, expects bank stocks to decline by another 20% to 30% or so over the next year.
"Initially the rising rate environment is a positive, but there's a crossover point where it starts to affect credit," Peabody said in an interview. "That's the point where we're at."
As the economic stimulus from Trump's December 2017 tax cuts fades, a growing number of traders and forecasters say the Federal Reserve may soon have to halt or pause its campaign to "normalize" monetary policy, after holding interest rates near zero for an unprecedented eight-year stretch following the financial crisis.
And because the biggest banks have been reluctant in recent years to share higher interest rates with savings-account holders, a catch-up is overdue. Standard & Poor's noted last week in a report that banks are now passing along about 25% of Federal Reserve rate increases to depositors, compared with less than 5% in early 2016.
The change is driven by heightened competition, with depositors becoming "increasingly rate-sensitive, likely to search for higher-yielding options to place their funds," according to the report. Back in early 2016, investors were so used to getting zero interest on their deposits that they didn't bother to switch banks. That meant JPMorgan, Citigroup, Bank of America and Wells Fargo & Co. (WFC) could keep basic savings-account rates close to zero without any serious threat of losing the customers.
The upshot is that banks are now likely to see diminishing returns from each additional rate hike by the Fed, a dynamic reflected in the firms' own disclosures about the sensitivity of their profits to certain market factors. Bank of America, for example, estimated at the end of 2015 that it would get $3.6 billion of additional interest revenue from a one percentage-point jump in rates, filings show. As of September, though, a similar increase would only bring an estimated benefit of $2.9 billion.
Even more problematic, investors are starting to fret that banks could face higher losses next year on the low-interest loans they've made in recent years, the brokerage firm Keefe, Bruyette & Woods wrote last week in a report.
Although households are in better shape than they were just prior to the 2008 crisis, businesses and governments have taken on more debt, and they could see higher costs from rising worker wages and Trump's import tariffs, according to the French bank BNP Paribas. Many corporate borrowers will have a heavier burden from interest payments on variable-rate loans.
"Credit risk is building," the Office of the U.S. Comptroller of the Currency, a key banking-industry regulator, warned last week in a report. "It is important for bank management to remain attentive."
For investors, it's a tough lesson in the reality of the banking business: Higher interest rates can be a double-edged sword, with fatter lending margins eventually followed by an economic slowdown and a surge in borrower defaults.
"The market is focused on late-cycle credit risks," analysts at another big U.S. bank, Goldman Sachs Group Inc. (GS) , wrote last week. Goldman's own shares have fallen 23% in the past three months.
Last week, the Wall Street research firm CFRA cut its assessment of financial-company stocks to "underweight" from "marketweight," citing the likelihood of an economic slowdown next year.
"Rising interest rates have been less of a benefit than expected," the firm wrote. "Corporate debt levels are elevated, and we are concerned banks will have to reserve more capital for the risk."
The pessimism has yet to be reflected in banks' earnings reports. Through the first nine months of the year, JPMorgan's net income is up 26% compared with a year earlier, though some of that improvement is due to the tax cuts. On a pretax basis, profits are up 15%.
As far as traders are concerned, however, the much-hyped interest-rate play in bank stocks is proving to have been both short-lived and underwhelming. Following the recent market pullback, big-bank stocks are up an average 6.8% annually over the three-year duration of the Fed's monetary-policy campaign. Such a track record compares with a 9.4% average gain for the S&P 500. So much for the outperformance.
JPMorgan press officials declined to make Dimon available. Last week, in an interview with CNBC, he described the economy as "strong," attributing the stock market's recent decline to investor jitters over the risk of a trade war with China.
"I don't think the Fed should be overreacting that the stock market went up or down, or because people are afraid of trade, or possible geopolitical events," Dimon said, according to a transcript provided by the network. "Normalizing is a good thing. The world will be much happier if America is growing and rates are going up a little bit then if we have a recession and rates go down. It's better for the world."
A golden age, no doubt. Or maybe just fool's gold.