With talk of a Fed rate hike at its September meeting increasing, following comments of Stanley Fischer and other Fed governors at Jackson Hole, bank stocks are enjoying quite a run. Bank of America is currently trading at $16.14, a nearly 45% gain from its February 2016 lows. Citigroup is up 38% and JP Morgan +28.5% (a nice game for Mr. Dimon who publicly purchased $26 million of its shares on February 12). The financial services ETF, "XLF" is up an impressive 27.5%.
Some of this gain was a bounce off the February lows, but a healthy share of the return has been produced over the past 30 days as focus turned toward the Fed's Jackson Hole Symposium. Rightly or wrongly, the market thoroughly believes that higher rates are good for banks, as long-suffering bank net interest margins profit by a higher interest rate lending environment.
Truth be known, a hike in the Fed funds rate, in and of itself, is negative for bank earnings. Such a rise in short term rates has to be accompanied by a far larger increase in term lending rates to produce net interest income benefit to the banks. Part of this disconnect has to do with the mystery surrounding the Fed. Despite the Fed's noble efforts at transparency, market participants remain convinced that the Fed has secret data insights, not otherwise available to the markets at large. If the Fed is moving on rates, the economy must be heating up and with it the UST 10-year, or so the thinking goes.
Of course, the Fed is not privy to some covert set of data, but rather is looking at the same economic data as everyone else. In fact, their prolonged hesitation over the most minor of (and nearly insignificant) rate increases should be ample evidence that the data on the economy is more confusing than it is compelling. Nonetheless, as the chatter rises, bank stocks head higher while utility stocks, bonds and gold - each of which thrive in a low interest rate environment - drift lower.
This being said, it's probably worth taking a look at how markets actually reacted in the days and weeks following the Fed's 25 basis point rate hike last December. As discussed in a previous post, in the several weeks following the Fed's December 15, 2015 rate hike, the 10-year UST actually fell in yield (bad for bank earnings, by the way) while utility stocks and gold posted some of their best gains in recent memory.
The XLF shows a similar phenomena, rising to a close of $24.44 on the day following the Fed decision, up nearly 32% from its August 2015 lows. But in the days that followed, the XLF quickly began to fade, falling nearly 5% the very next day. By the time of the February 2016 lows, the XLF had fallen nearly 20%. Eerily, the XLF today, as we approach the September Fed meeting stands at precisely the same level, $24.56, as it did on the day prior to the December Fed meeting.