Saturday, July 6, 2013

Why bank stocks are unconcerned by higher rates

Many analysts predict that banks will be hurt by higher interest rates.  Yet the best leading indicator of banks’ future profits – financial sector stocks – aren’t showing the slightest concern by this prospect.

Indeed, judging by the performance of the Bank Index (BKX) and the Broker Dealer Index (XBD), financial institutions seem to be quite at home with the idea of higher interest rates.  This, we are told by some experts, is because higher rates allow banks to loan more money.  Insurers also generate more returns on their investment portfolios with rising rates without having to rely on premiums. 

Despite the nearly 9% jump in the Treasury Yield Index (TNX) on Friday, July 5, bank stocks were up by an average of 2.62% while broker/dealers were up 2.39%.  Both the XBD and the BKX made new 52-week highs in contrast t the S&P 500, which is still below its previous high from May.

Rising rates aren’t good for everyone, however.  Homebuilders and REITs are struggling under the weight of higher interest rates, as can be seen in the daily chart of the Dow Jones Equity REIT Index (DJR).

Yet rising rates are providing a near-term boost to home buying.  As Dr. Ed Yardeni has pointed out, homebuyer’s initial reaction to rising mortgage rates has prompted would-be home buyers to close their deals as quickly as possible. 

Could it be that the reason for the bank stock rally despite rising rates is that banks are benefiting from the short-term stimulating effect of mortgage activity?  Once this wave of closings is completed, what then can we expect from bank performance?  I would venture a guess that the bottoming 120-year cycle in 2014 will suck the wind out of banks’ sails , thus defeating the expectation of increased loan activity.

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