As Wall Street searches for a catalyst to stop the slide in the stock market, some strategists are looking to the banking sector for help.
"US bank stocks are the market's Achilles' heel just now," DataTrek Research co-founder Nicholas Colas wrote in a note to clients this week.
"[Bank stocks] need to participate in any recovery rally in order to validate the notion that higher interest rates do not doom the US economy to a recession next year. If you are very bullish here, this is the group for you."
Hammered during the regional banking crisis in March, bank stocks have notably lagged the S&P 500 this year, even as they've recovered from their lows reached back in May.
As of Thursday, the S&P Bank Index ETF (KBE) and the S&P Regional Bank Index ETF (KRE) were down more than 20% and 30% year to date, respectively. The S&P 500, in contrast, has gained nearly 11% this year.
Amid the S&P 500's 5% slide over the last month, both bank indexes have lagged the benchmark index, falling more than 7%.
Liz Ann Sonders, chief investment strategist at Charles Schwab, told Yahoo Finance financials have been a "missing ingredient" in the market's rally from lows reached in October 2022.
Gerard Cassidy, an analyst at RBC who covers large banks, said the path forward for these firms will likely depend on the Fed's interest rate path.
If the Fed is done hiking now, then bank stocks are likely "bottoming out" at the lowest valuations seen in decades, in Cassidy's view. But if inflation reaccelerates and the Fed is forced to keep raising rates then bank stocks could be in for more trouble.
"That's the bear case for the banks," Cassidy said about the possibility of more hikes. "Now that's not ... a consensus call, and we're not calling for that. But that's the long-tail risk for the banks today."
September forecasts from the Federal Reserve suggested one additional rate hike would be necessary in 2023 before rate cuts begin next year.
As for whether the time is now to make this bet, Colas, for his part, leans "more to the cautious side on banks right now."
"If the bears are right and 'something is going to break' because of suddenly higher interest rates, then that 'something' will almost certainly involve US banks," Colas wrote.
"If higher yields cause a recession, then loan losses will rise. If higher yields hit the value of a bank's bond portfolio, it may need to raise more capital or sell at a distressed price. And, of course, those outcomes are not mutually exclusive."
Beginning next week, banks will again set the tone for earnings season with JPMorgan Chase (JPM) expected to announce third quarter earnings on Friday, Oct. 13.
Josh is a reporter for Yahoo Finance.
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