The Fed's next move won't be as helpful to bank stocks as investors expect

Bank stocks have been rallying since the spring on the hopes that interest rates might rise this year.

Higher interest rates, the thinking is, mean banks can earn more from their core lending businesses. The Nasdaq Bank Index, for example, is up 4.4% in the past three months.

But those gains may be based on a flawed investment thesis, according to Keefe, Bruyette & Woods strategists.

“We believe that interest rate sensitivity of financial stocks is largely an overrated investment theme for the group and for individual stocks.”

There’s a few reasons for this, according to the KBW strategists:

  • Bank stocks in Europe and Japan, where central banks are loosening monetary policy, have actually outperformed US bank stocks this year. That suggests that the relationship between interest rates and bank stocks isn’t as clear as some investors would like to think.
  • Any extra profits that come from higher interest rates are probably going to be offset by the fact that banks will have to set more money aside to protect against default on those loans.
  • Even if the Fed hikes rates in September, interest rates could stay low for a very long time — and that will damped enthusiasm among bank investors looking for a big bump in profits.

The report said: “Our conclusion is that higher interest rates are not a panacea for financial stocks, and expectations for future performance will be determined by the context of interest rate increases. If the Fed hikes rates and loan growth, economic activity continues to accelerate in the U.S., and credit quality remains stellar, the outlook for financial stocks is positive. However, if those factors don’t all line up, interest rate increases alone could result in mixed if not poor performance for U.S. financial stocks.”

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