This was supposed to be a big year for bank stocks to enter a longterm “golden age” fueled by rising interest rates, tax reform, and a more relaxed regulatory environment. But financial stocks have failed to deliver. Now, one of the sector's biggest bulls has thrown in the towel. Dick Bove, chief strategist for Hilton Capital Management, is telling investors to sell most bank stocks on the belief that rising interest rates, rather than bolstering bank profits, will actually work against them. “The market doesn’t have a clue based upon the things I hear,” Bove told CNBC.

Bank Stocks Lag the S&P 500 and Now Face Declines

 KBW Nasdaq Bank Index (BKX)  + 0.2%
 S&P 500  + 6.7%
 Dow Jones Industrial Average  + 6.1%

Source: CNN Money, YTD 10/10

His bearish outlook comes even as analysts are forecasting banks will post their highest profits since the financial crisis in the upcoming third quarter earnings season, which for banks, is set to kick off this Friday. A report by Goldman Sachs says bank earnings rose 38% in the third quarter, according to consensus estimates, the second-fastest increase among the 11 S&P industry sectors. But beneath the booming profit numbers there are reasons to be concerned. (To read more, see: 4 Reasons Bank Stocks Will Rise Longterm: Bove).

“The bank stocks are going to go lower, and if you own some, you better lighten up,” says Dick Bove.

What it Means for Investors

Bank profits have been strong all year, but much of that can be attributed to corporate tax cuts rather than strengthening fundamentals. One of the biggest worries is weak loan growth despite a U.S. economy that sped up in the second quarter. Mortgage growth, for instance, has begun to slow. That’s bad news for big lenders including JPMorgan Chase & Co. (JPM), Morgan Stanley (MS), Citigroup Inc. (C), Bank of America Corp. (BAC), Wells Fargo & Co. (WFC), and Goldman Sachs Group Inc. (GS).

The normal adage is that as interest rates go up, banks should have more room to increase the rates they charge on loans relative to the ones they pay on customer deposits. That would give banks more flexibility to increase their net interest margins. But if rising interest rates deter consumers and businesses from borrowing, that cuts off a lucrative source of bank profits.

Rising interest rates can also make other financial assets on bank balance sheets less attractive, causing their values to fall. This is making it hard for investors to evaluate the strength of bank balance sheets. “Investors don’t have a clear picture as to what the value of bank assets are. Bank capital in real terms is eroding,” says Bove, per CNBC. (To read more, see: 3 Bank Stocks That Face Further Declines).

Bank Stocks Bove Recommends

 Comerica

 CMA

 Silicon Valley Bank (SVB Financial Group)

 SIVB
 PacWest Bancorp

 PAC

Source: CNBC

Looking Ahead

While Bove presents a bearish outlook for the financial sector as a whole, he sees bright spots in Silicon Valley-focused banks. He favors Comerica Inc. (CMA), SVB Financial Group (SIVB), and PacWest Bancorp (PACW). Among the bigger banks, JPMorgan has led its peers for much of 2018 in stock performance and may continue to shine.