6 Big Bank Stocks Flash Warning Signals

Bank stocks rose by about 19 percent over the past year, as measured by the KBW Nasdaq Bank Index, as investors anticipated that rising interest rates, deregulation, and tax reform would fuel these shares even higher in 2018. But big warning signs are emerging that all is not well with the banking industry and with bank stocks, especially the biggest six U.S. players. Investors now see signs of slowing long-term growth stemming both from industry trends and also from new, more constrictive rules by the Federal Reserve. While first quarter earnings reports looked strong on the surface, the shares of several big U.S. banks declined in response. As Ben Barzideh, a wealth advisor at Chicago-based Piershale Financial Group, told Barron's: "The market has not been impressed because the reasons for the earnings beat are of low quality, such as tax benefits or one-off boosts. These are factors that only increase revenues temporarily."

The six big U.S. banks represent a mixed bag in terms of price performance for the year-to-date through April 20: JPMorgan Chase & Co. (JPM), +5.3%, Citigroup Inc. (C), -5.5%, Goldman Sachs Group Inc. (GS), -0.8%, Morgan Stanley (MS), +4.2%, Bank of America Corp. (BAC), +2.9%, and Wells Fargo & Co. (WFC), -12.9%. The S&P 500 Index (SPX) is down by 0.1% YTD, while the KBW Nasdaq Bank Index (BKX) is up by 0.6%. The KBW index hit its low close for the year on Wednesday April 18, down 1.7% YTD as of that point, then rallied on Thursday and Friday, per Yahoo Finance.

Stressing Over Stress Tests

A new cloud hanging over bank stocks is the Federal Reserve's proposed changes to capital requirements that may force banks to keep larger capital buffers, thereby restricting the growth in dividend payouts and share repurchase programs, The Wall Street Journal reports. This is creating a new set of uncertainties that have been weighing on bank stocks, per the Journal, and which probably will not be resolved until the Fed completes its annual bank stress tests later this year. Former FDIC head Sheila Bair is among those who have criticized the recent loosening of capital requirements. (For more, see also: 4 Early Warning Signs Of The Next Financial Crisis.)

'Unrealistic Expectations'

For its part, Barron's speculates that investors may have developed "unrealistically high expectations for financials," anticipating continued deregulation by the Trump administration that will deliver yet more earnings boosts. The recent weakness in their stock prices suggests diminished expectations.

Matt Maley, equity strategist at Miller Tabak, is somewhat more pessimistic. As he wrote in a commentary for CNBC: "One of the most discouraging things to emerge in the market is when a stock, or a group, reacts poorly to good news; this tends to indicate that the good news is already priced into the stock, and there aren't any buyers to take the stock higher." He cited JPMorgan Chase, Citigroup, Goldman, and Bank of America as bank stocks that eventually fell after announcing strong earnings.

As quoted in another Barron's story, Brian Kleinhanzl, an equity research analyst at Keefe, Bruyette & Woods, echoes Ben Barzideh's comments. Kleinhanzl notes that Citigroup beat first quarter estimates largely on the basis of a lower tax rate and lower than expected provisions for losses, rather than organic growth, leaving investors unimpressed.

Indeed, while tax reform has placed bank earnings on a higher plateau, the downside is that it represents a one-time benefit when year-over-year earnings comparisons are made. For investors who focus on such comparisons, this source of earnings growth is now a spent force.

'Abuses and Breakdowns'

Wells Fargo has turned in the worst YTD performance of the big banks listed above, probably in anticipation of a rough 2018 overall. As quoted in another Barron's story, John Pancari, senior equity analyst at Evercore ISI, notes that the bank is expected to suffer an earnings hit of up to $400 million in 2018, the result of a consent order with the Federal Reserve, but that only a small portion thereof was reflected in first quarter results.

Wells Fargo has been penalized for "widespread consumer abuses and compliance breakdowns," with the Fed announcing that it "would restrict the growth of the firm until it sufficiently improves it governance and controls," per the Fed's February 2 press release. The Fed's action was taken in response to the scandal involving the opening of 3.5 million fake accounts at the bank, and the negative impact may exceed $400 million and last beyond 2018, CNBC reported.

'Taking a Breather'

Joe Heider, founder and president of Cleveland-based Cirrus Wealth Management, is somewhat more sanguine about bank stocks. As he indicated to Barron's: "The banks have been underperforming for several years. This simply may be a case of bank stocks getting ahead of themselves. The bank stocks may be taking a breather at this point. They can regain leadership at a later date."