(Bloomberg) -- After a year of trudging through industry uncertainty, bank stocks have been on a tear of late.
The KBW Bank Index rallied nearly 10% this month to close at the highest level since August 2022 on Tuesday, before dipping a bit Wednesday. It was the index’s best monthly gain since December. Regional banks have done even better, soaring 19% for their strongest month since November 2016. More broadly, financials was one of the top performing S&P 500 sectors in July.
There are various reasons for the surge. The latest batch of earnings showed banks are approaching the bottom of a slowdown in net interest income. At the same time, positive news in the fight against inflation sparked a rotation from tech stocks into companies that would benefit from Federal Reserve rate cuts — chief among them banks. Mid-month, the group got a boost from bets that Donald Trump would win the presidency and usher in a softer regulatory environment.
“You have an inflection of earnings, interest rates and regulation,” said Mike Mayo, a prominent banking analyst at Wells Fargo & Co. who’d called for the sector to rally this year. “It’s an inflection for both the macro and the micro, and that’s making bank stocks looking increasingly interesting.”
The KBW Bank Index slipped on Wednesday in the wake of the Fed meeting, as tech stocks soared. The index ended the day down 0.8%.
The July rally continues a rebound from a rough stretch for US bank stocks, which had been bedeviled by concerns about harsher regulation and declines in lending profits. The KBW Bank Index lagged the S&P 500 for two years — though the biggest banks fared better than smaller peers — before the sector shifted to outperformance this year.
That changed when inflation data earlier this month spurred investors to reallocate funds from the biggest tech stocks to small-caps and other straggling sectors, sending the KBW Regional Banking Index to is best day in four months.
There’s growing optimism on the regulatory front. Fed Chair Jerome Powell said this month that regulators are nearing agreement to changes for their bank-capital plan in a move that would mark a big win for Wall Street.
There was also a brief boost from what was seen as Trump’s rising prospects for an election win in November, with the biggest bump coming after an assassination attempt at a weekend rally. A potential Trump administration has bolstered hopes for lighter regulation for industries including banks. Banks held those gains even as the latest Bloomberg News/Morning Consult polling, shows Democrat Kamala Harris gaining, now in a dead heat with the former president in key states.
“Our perspective is that Banks start with a less challenging valuation set up; should have lesser exposure to tariff proposals; may benefit as the Fed narrative shifts to less hawkish,” Citigroup US equity strategist Scott Chronert wrote in a note. “Regulation relief adds one more element to this industry group as a fairly straightforward ‘Trump trade.’”
Fed day Wednesday included Powell saying a rate cut may come as soon as September, which could help banks begin to lower what they pay for deposits, and ease concerns about credit deteriorating in the high-rate environment.
“Banks had been all but left behind since SVB, the regional bank crisis last year,” said Jamie Cox, managing partner at Harris Financial Group. “With the potential for lower regulations and a steepening yield curve, they’re investable again.”
Amid the macro shifts, banks also reported solid earnings. The wave of reports earlier in July from major US banks left Morgan Stanley analyst Betsy Graseck leaning toward the bull case for the group, saying that net interest income shifting “from a headwind to a tailwind will be a key driver of positive operating leverage in the back half of the year and into 2025.”
The largest Wall Street banks have been rallying this year, bolstered in part by improving capital markets activity. JPMorgan Chase & Co. and Goldman Sachs Group Inc. have both notched record highs.
“We have been pounding the table on the capital markets rebound theme, and 2Q continued to support this outlook with trading and investment banking revenues beat consensus across the majority of our coverage,” Graseck wrote.
To be sure, there are signs the rally might have already run its course. The relative strength index for the KBW Bank index has been hovering around overbought territory for weeks.
Baird analyst David George downgraded a pair of regional bank stocks this month due in part to an argument that there’s limited upside for the sector and the “Trump trade” doesn’t make sense this election cycle.
“With most banks hitting 52-week highs, and sentiment shifting in one of the biggest U-turns we have ever seen, our valuation framework and through-the-cycle thought process suggests more limited upside in most bank names,” the analyst wrote. “Furthermore, we believe this replay of the Trump trade makes little sense to us this time around.”
--With assistance from Natalia Kniazhevich, Alexandra Semenova and Esha Dey.
(Updates throughout for market close, starting in the second paragraph.)
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