While the stock market has cooled off a bit in recent weeks after a volatile first quarter, the action continues in the bond market.
With inflation remaining extremely high (although showing small signs of further cooling) and the Federal Reserve signaling its determination to raise rates substantially this year, bond yields have continued to rise. The 10-year US Treasury bond hit 2.83% last week, up from 2.39% on April 1 and 1.52% on the last day of 2021.
Much of the attention this year has focused on the headwinds that meant higher rates for shares of fast-growing companies, especially last year’s high-flying technology and communications names. More recently, higher mortgage rates have hit homebuilders and furniture retailers.
Another interesting story has been that of bank stocks. Many bank stocks entered 2021 on a roll. Among the industry giants, Wells Fargo (WFC) rose 61% last year, Bank of America (BAC) jumped 49.6% and JPMorgan Chase (JPM) rose 27.7%. Those returns helped fuel the Financial Select Sector SPDR ETF with a host of banks. (XLF) 34.8% in 2021.
A major reason for the rally was the fact that long-term interest rates were rising, but the Fed was keeping short-term rates low. The result was an “increasingly steepened yield curve,” which is good news for bank earnings. Banks can bring in cash at low rates in the short term and lend to customers at higher rates in the long term, increasing their net interest income. At the same time, the economy is limping along and creates an excellent lending environment. Pretty much a Goldilocks scenario.
The downside was that valuations for many bank stocks were at or above Morningstar’s fair value estimates. Bank of America, for example, ended last year 17% above its estimated fair value.
As Morningstar strategist Eric Compton warned in January, “Most of the banking sector theses we see are simply ‘higher rates equals good earnings momentum, which means you should buy banks.’ Eventually, we think investors will have to go beyond this.”
That story has changed significantly in 2022. As it became clear that the Federal Reserve will raise the fed funds rate, short-term market rates soared to the point where two weeks ago, the yield on the two-year note rose briefly above that. than 10 years, a dynamic known as an “inverted yield curve” and which removes the tailwind of banks’ net interest earnings.
At the same time, the economic outlook has been cloudier with inflation remaining higher than many expected and reducing consumers’ ability to spend. Ripples from the Russian invasion of Ukraine have only increased uncertainty and in some cases forced global banks to take losses related to the Russian attack and sanctions.
Earlier this month, Compton wrote “with high interest rate expectations, we believe it is imperative that investors consider their exposure to rate risk. There is a downside to prices today if the higher rate narrative falls apart and economic growth stalls. With some indicators of increasing recession risk, we can see this playing out in real time.”
Meanwhile, several bank stocks have taken a beating this year. With that has come a drop in valuations.
So what’s next for bank stocks? As the first quarter earnings rolled in, the picture has been mixed.
With JPMorgan, while overall first-quarter earnings were hurt by higher expenses and a drop in investment banking fees, Compton writes that the bank’s results suggest a still-strong net interest income outlook.
For Wells, Compton called the first-quarter earnings report “disappointing,” and while net interest income was basically flat, “the news wasn’t all bad,” he wrote. “Due to recent changes in rate expectations, as well as better-than-expected loan growth, management now believes they could potentially increase net interest income by a mid-year amount, roughly double last quarter’s 8% growth guidance.
We will have more clarity as earnings continue to be released in the week ahead, with Bank of America due on Monday.
Among the events scheduled for next week:
- Monday: Bank of America earnings.
- Tuesday: Netflix (NFLX) and Johnson & Johnson (JNJ) Profits.
- Wednesday: Tesla (TSLA) and Procter & Gamble (PG) Profits.
- Thursday: United Airlines (UAL)american airlines (AAL)Huntington Bancshares (HBAN)AT&T (T)and Adjust (BREAK) they are all due to the earnings report.
For the trading week ending April 14:
- Morningstar’s US market index was down 1.82%.
- The sector that performed best was basic materials, with an increase of 0.96%.
- The worst performing sectors were technology, down 3.39%, and health care, down 2.77%.
- Yields on the 10-year US Treasury note rose to 2.83% from 2.71%.
- Oil ended the week up 8.84% to $106.95 a barrel.
- Of the 866 US-listed companies covered by Morningstar, 355, or 41%, rose, while 511, or 59%, fell.
What stocks are up?
The best performing stocks last week were VNET Group (VNET)IT’S AB (IT’S AB)delta airlines (DAL)American Airlines and Southwest Airlines (LUV).
Several travel stocks rose after Delta Air Lines outperformed gains. American Airlines and United Airlines rose higher ahead of their earnings calls on Thursday. Hotel stocks also closed higher, led by Park Hotels & Resorts (PACKAGE)Pebble Brook Hotel (PEB)and Host Hotels & Resorts (HST).
Retail Stores Burlington (SPECK)macy’s (METER)and GAP (GPS) closed higher after US retail sales rose 0.5% in March despite inflationary pressures. While most of the increase was attributed to higher gasoline prices, spending rose in several categories, including apparel, electronics and home appliances.
What stocks are down?
The worst performing stocks last week were Just Eat Takeaway (JTKWY)infosys (INFY)Generac Holdings (GNRC)ericsson (ERIC)and Bed Bath & Beyond (BBBY).
Bed Bath & Beyond shares fell after the retailer published Disappointing results for the fourth quarter, an earnings per share loss of 92 cents, below the market consensus of a profit of 3 cents, according to FactSet. The earnings results also dragged down shares of India-based IT services provider Infosys.
Health care stocks reversed gains from the previous week, with diagnostic and research companies such as Idexx Laboratories among the worst performers. (IDXX)illuminate (ILMN)and Danaher (HDR).
Semiconductor companies extended losses from the previous week, with Synopsys (SNPS)Nvidia (NVDA)and advanced microdevices (AMD) lower.