Bank investors are now betting 2024 could be the start of another 1995
The start of a new rate-cutting cycle at the Federal Reserve has bank investors hoping for a return to 1995.
That was the year the banking industry began one of its best runs in US history following a series of new rate cuts from the Fed and a soft landing engineered by then-central bank chair Alan Greenspan.
An index broadly tracking the sector finished 1995 up more than 40%, outperforming the S&P 500 (GSCP). And that outperformance would hold for two more years.
Could it happen again?
So far, bank stocks are off to a good start. This year, the same banking industry index that soared in 1995 (^BKX) is up more than 19%, just behind major stock indexes.
Meanwhile, another index (XLF) tracking big banks along with other major non-bank financial firms is up 21%, just ahead of major indexes.
"History isn’t likely to repeat, but it may rhyme," Mike Mayo, a Wells Fargo analyst who covers the country’s largest banks, said of the 1995 comparison.
Mayo isn’t counting on next year being as good as that mystical year, but he does see similarities.
On the three occasions (1995, 1998, and 2019) where the Fed cut interest rates and a recession didn’t follow, bank stocks on average sold off initially after the first cut, then rallied several weeks after —outperforming the S&P 500, according to analysis from Wells Fargo Securities.
But a wider review of the past six rate-cutting cycles (including three that were followed by recessions) shows the industry’s outperformance doesn’t usually last long. Only in 1995 did banks rally more than the broader stock market for longer than three months after the first rate cut.
And back then, it wasn’t just monetary policy that lined up right for banks.
Rough start
Lenders actually started 1995 in rough shape, as major institutions buckled.
That included the municipality of Orange County, Calif., declaring bankruptcy in December of '94 and British merchant bank Barings, which collapsed in February of 1995.
Banks with big trading desks were also still recovering from serious losses from a bond market wipeout the year before — and commercial real estate lenders were still seeing loan losses from a crisis that began in the late '80s.
Meanwhile, real US GDP even slipped below 1% over the first half of the year. And yields on the longer-term 10-year Treasury plunged by 250 basis points.
Yet, crucially, those longer-term yields remained higher than short-term notes. That allowed banks, which borrow at short-term rates and lend at long-term rates, to profit by a wider margin from the difference.
What also helped banks in 1995 was a new period of loosening bank regulation, starting with a federal law signed by then-President Bill Clinton the year before.
That law eliminated restrictions that stopped banks from opening branches across state lines, setting the stage for a period of deregulation that would eventually give rise to the country’s mega-banks like JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C).
Banks are largely having their way in Washington once again.
While bank regulation has gotten more aggressive since the Trump administration, big banks have more recently grown bolder in confronting regulators over disagreements.
And they won a big victory earlier this month when regulators watered down new bank capital plans that would cut requirements for big banks by half from the initial proposal.
"It looks like the regulatory pendulum may be swinging back that way," Mayo said.
Not all moves in the nation's capital are to the banks' liking, however. The Justice Department recently scrapped their own guidelines in approving bank mergers that have stood in place since 1995.
Dream — or fever dream?
For the time being, the expected impact of interest rate cuts on bank earnings appears somewhat mixed.
Lenders that benefited from high rates are likely to see less profits, while those that lagged are expecting a boost.
"There's no argument that the falling rates are good for banks. I'm just not sure that it's for the same reasons that it was in '95," said Allen Puwalski, chief investment officer and co-portfolio manager at Cybiont Capital.
A lot also hinges on the ability of the Fed to nail its soft landing, keeping the US economy out of a recession as inflation falls.
"Our intention is really to maintain the strength that we currently see in the US economy," Fed chair Jay Powell told reporters on Wednesday.
Even without a US recession, a repeat of 1995 would still require loan growth and the continued revival of investment banking.
At a Barclays conference last week, some bank executives, including Bank of America CEO Brian Moynihan and PNC (PNC) CEO Bill Demchak, reiterated their expectations for better earnings in 2025.
Others didn’t.
JPMorgan Chase COO Daniel Pinto told investors that analysts are “a bit too optimistic” about how much the bank will earn in 2025.
“Over the course of the quarter, our credit challenges have intensified,” Russell Hutchinson, CFO of Ally Financial (ALLY), said of the bank’s retail auto business the same day.
Gerard Cassidy, a RBC Capital Markets analyst, expects banks to see higher revenues next year but also more credit problems.
"We do expect to see incrementally higher loan loss provisions in the next 12 months, in our view," Cassidy added.
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto, and other areas in finance.
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