Why Big Bank Stocks Are About to Crumble

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

The bank stocks have had a fantastic run with the NASDAQ KBW Bank Index (BKX) surging by nearly 55% since November 8, 2016, rising from roughly 75.50 to 116.50 on January 30, 2018. Dreams of higher interest rates, deregulation and tax cuts has boosted bank profits. The S&P 500 has also surged over the same period, jumping by nearly 32%. But since January 30, the bank index has dropped from approximately 116.50 to 106.40, a decline of about 9%, vs. a drop of only 5% for the S&P 500. (For more, see also: Top Bank Stocks.)

Signs are emerging that bank shares may be set to tumble further, as earnings estimates suggest a significant slow down in earnings growth. A technical analysis of the NASDAQ KBW Bank Index suggests a decline of nearly 8.5% from its price of approximately 106.40 on April 13.

Technical Breakdown

The bank index has recently fallen below an uptrend that began in the summer of 2016. After the election of President Trump, the bank stocks continued to rise along that uptrend but has now fallen below it, as of the end of March. Despite several attempts, the index has been unable to rise back above the critical trend line. The relative strength index (RSI) is also trending lower and would need to fall below 30 to reach oversold conditions, from its current level around 45. The next region on the chart of technical support comes around 97.5, a decline of 8.5%. 

Slowing Growth

Earnings on the banks are expected to slow considerably in 2019 and 2020, from a blistering pace in 2018. JP Morgan Chase & Co. (JPM) is expected to see its earnings grow by over 30% in 2018, but that growth is expected to decline to only 8.6% in 2019, and 8.2% in 2020. Meanwhile, Citigroup, Inc. (C) is expected to see its earnings growth drop from 26% in 2018, to only 15.7% in 2019, and 16% in 2020. But what may be even more problematic is Citigroup's earnings growth is expected to come on even slower revenue growth rates. In fact, Citigroup is only forecast to see its revenue grow by 4% in both 2019 and 2020.  

C Annual Revenue Estimates Chart

C Annual Revenue Estimates data by YCharts

Contracting Interest Rate Spreads

The banks may also struggle should the spread between short-term and long-term interest rates continue contracting. Banks earn a portion of their income from interest income, and should the spread between short and long-term rates continue to contract, it could dampen revenue expectations, impacting profits. The spread between 10-year U.S. Treasury and 2-Year US Treasury is now less than 50 bps. 

10-2 Year Treasury Yield Spread Chart

10-2 Year Treasury Yield Spread data by YCharts

There are plenty of banks left to report results this earnings season with Bank of America Corp. (BAC) expected to report results on Monday, April 16, which could help to turn the sentiment on the group to a more positive one. But for now, slowing growth and contracting interest rate spreads may prove to be the banks most significant headwinds. (For more, see also: Why Bank of America Sees 2018 Stocks Returns Near 20%.)

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the founder of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of two to three years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

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