Dividend-rich bank stocks are late to the rally, but their bounce may be a good sign for market

Stock Market

The bounce in financial stocks could be a good sign for the broader stock market if it continues.

The financial sector is like an early warning signal for the economy, and the stocks have been lagging the broader market and every other sector but consumer staples. They have gained just 25% since the March 23 market low, compared to the 33% gain in the S&P 500.  Financials are also about 29% off their January high.

“I  think a bounce in banks is good in general,” said Sam Stovall, chief investment strategist at CFRA. “Usually the financials in general, the banks in particular are the canary in the coal mine because the economy really can’t grow unless the banks are lending. If investors believe people will not be borrowing then they will be borrowing then they have a lot of problems.”

The Financial Select Sector SPDR ETF rallied 5.1% Monday, as banks surged after Fed Chairman Jerome Powell said the Fed can do more to help the economy. Banks also moved higher with the broader market on optimism about a potential coronavirus vaccine, which showed good results in early trials. The financial sector, up 5.3% Monday, was third-best sector behind energy and industrials.

Investors have avoided the group for fear the recession will crush profitability and result in rising loan losses. The stocks rallied last week, after Powell said he opposed negative rates, which would be bad for bank profitability, but then fizzled Friday.

Mike Mayo, Wells Fargo banking analyst, said there was also positive news for the group, when Warren Buffett’s Berkshire Hathaway disclosed that its holdings continue to be heavily in banks, even though it sold a large chunk of a long-held stake in Goldman Sachs and shed some of its JPMorgan stock.

“Buffett still has basically his biggest investment in history in the banks. That’s quite a statement. He’s not afraid to bail when something’s not going the way it should. The best investor of all time has his biggest investment ever, less 3%, in banks. Maybe he knows something the market is missing,” Mayo told CNBC in an email.

Mayo notes that Buffett’s holdings remain in Bank of America, Bank of New York Mellon, and M&T Bank. Berkshire also built higher stakes in PNC and  U.S. Bancorp, Mayo added. He said for short-term investors, bank shares may see a catalyst if the yield on the 10-year rises to 1.25% as Wells Fargo expects by years end. Rising yields Monday were also a factor behind the gain in banks as the 10-year edged up to 0.72%.

Some investors have been worried about the security of bank dividends, and their stocks have been punished for that. Citigroup’s yield is about 4.5%, JPMorgan is about 4%, PNC is 4.4%, and Wells Fargo is 8%.

Fed Vice Chairman Randal Quarles told the Senate Banking Committee last week that the Fed’s stress tests this summer will determine whether banks can continue with their dividends, and that they have been changed to focus on the pandemic. The results are expected at the end of June.

Stovall said if growth does rebound with the reopenings, as the market expects, it will be good for banks stocks. “If they’re going to do well, they have the ability to gain and grow that dividend,” he said. “Right now the yields look very attractive.”

“The evidence is overwhelming that when financials outperform the broad market rises,” said Julian Emanuel, head of equities and derivatives strategy at BTIG. He said Powell’s comments last week that the Fed was opposed to negative rates was a positive for the group, since negative rates would hit bank profits.

“PNC’s receiving $14 billion to $17 billion for its BlackRock stake and telling the market that they were likely to be a buyer of a bank, along with Powell, just changed the psychological tone,” said Emanuel. “In an underweighted, shorted sector … we think investors really made an intellectual mistake.”  PNC said last week it was selling its 22% stake in BlackRock.

Emanuel said investors are too worried that the reserves banks set aside during the first quarter earnings to cover potential loan losses were a negative comment. “We think the real message was they actually were acting prudently and conservatively by setting aside those reserves because they could, unlike 2008, when they couldn’t send the message to the market because they were too busy fighting their own fires,” he said.

Stovall said investors have also dipped into small caps recently, also underperformers. “It seems like investors want to fill the vacuum left by financials, and mid and small caps. They jump in, but they’re very nervous so they jump out at any hint that the movement might not be sustainable,” he said. 

–CNBC’s Hugh Son contributed to this story

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