As far as economic cycles go, this one is moving in slow motion. And that could be a bullish sign for U.S. bank stocks including Action Alerts Plus holding JPMorgan Chase & Co. (JPM) , Bank of America Corp. (BAC) and Action Alerts Plus holding Citigroup Inc (C) .
Sandler O'Neill + Partners, a brokerage firm specializing in banks and other financial companies, says the U.S. economy is hitting major milestones just as in previous growth cycles. It's just doing so at one-third the speed.
Take the Federal Reserve latest series of interest rate increases, for example. The central bank's first rate hike since the recession of the late 2000s came six and a half years later, in 2015. That's roughly three times the Fed's average wait of two years following prior recessions, Sandler O'Neill Chief Strategist Robert Albertson wrote Monday in a report.
Reinforcing the theory, it took about eight and a half years following the recession for the signs of accelerating wages to emerge, according to Albertson; then last week, a report showed that annual wage growth hit 2.9%, triggering inflation concerns that had been mostly absent for years. In prior economic cycles, it's taken two to four years for wage growth to reappear.
The takeaway is that, this time around, with the economy progressing at a slower pace, there's plenty of time left to profit from bank stocks, typically among the biggest beneficiaries of growth cycles. Banks could benefit from fatter lending margins and faster loan growth even as they control expenses and pocket more profit due to President Donald Trump's new tax-cut law, according to Albertson.
"An elongated cycle is also a slower cycle," Albertson wrote.
The strategist's timeframe offers solace to investors fretting that last week's plunge in U.S. stocks - banks included - might signal the start of a deeper downturn. During the 2008 financial crisis and the ensuing recession, share prices of U.S. banks tumbled roughly 40%.
Last week's 5.2% drop in the Standard & Poor's 500 Index was the biggest in two years, triggered by investor concerns that rising inflation might lead to higher interest rates that in turn might sap the appeal of stocks.
The decline in bank stocks confronted analysts and investors with a conundrum: In recent years, many of them have argued that higher interest rates would bring a benefit to banks in the form of wider net interest margins - the difference between what banks collect on loans and other assets and what they pay out on deposits and other borrowed funds.
The concern, according to Keefe, Bruyette & Woods, another brokerage firm specializing in financial companies, is that worries over inflation might force the Fed to raise rates so quickly that the earnings benefit turns into a drag.
Such a scenario could saddle banks with falling stock markets, slower growth, higher loan losses and increased deposit rates, reducing earnings per share by 11% this year and 15% in 2019, analysts at KBW estimated Tuesday in a report. Among the biggest U.S. banks, Citigroup would see the biggest earnings decline next year, at 17%.
"Normally, the increase in long-term rates that we have seen in 2018 would be positive for bank stocks, but if rates move too quickly and inflation picks up, then the Fed may have to increase rates at a faster pace, and that could be negative for banks," the analysts wrote.
Dick Bove, a five-decade analyst at the brokerage firm Vertical Group, says he never bought into the premise that higher interest rates translate to improved bank earnings. That's because banks hold massive amounts of fixed-income securities and loans whose prices drop, just like all bonds, when interest rates rise. There's also competition: Banks have to compete on loan pricing just as aggressively as they do for deposits, according to Bove.
But he argues that stronger economic growth will lead to more loans and transactions, which he sees as a key driver of bank earnings. The fiscal stimulus from the tax cuts should keep the economy humming this year, Bove says.
"We're stimulating the economy so aggressively that the probability is high that the banks are going to show good earnings for three to four years," Bove said in a phone interview. "Loan volumes will increase dramatically, and therefore all of the excess capital and liquidity that these banks have will be put to use generating income."
Even after last week's pullback, banks are still sitting on big gains. Bank of America, based in Charlotte, North Carolina, is up 33% over the past 12 months, while JPMorgan and Citigroup, both based in New York, have each climbed 27%.
The Federal Reserve has raised short-term interest rates five times since late 2015 to the current range of 1.25% to 1.5%, and officials at the central bank anticipate another three increases this year.
That's just a sign that financial conditions are finally starting to normalize a full decade after the 2008 crisis, said Dave Hendler, principal at Viola Risk Advisors, a bank-analysis firm in Montebello, New York. For years, the Fed held rates close to zero to stimulate the economy.
"The morphine drip of central bank stimulus is being taken away, so the market's got to adjust," Hendler said in a phone interview. "But it's healthy for the economy. There's going to be consumer loan growth, credit cards, more mortgage activity, and auto lending is still going to be there."
Sandler O'Neill's Albertson says economic growth, unadjusted for inflation, is currently tracking above 4%, which could imply six future Fed interest-rate hikes of 0.25 percentage point each. But the economy is picking up slowly and steadily enough that most industries are likely to see revenue and earnings growth. And the Fed is unlikely to raise rates so much that a new recession develops, according to Albertson.
"It is no surprise that markets would over-react as they reverse their future bias on rates for the first time in a decade," Albertson wrote in the report. "But it does not follow that the degree of rising rates should be exceptional."