(Bloomberg) -- With the Federal Reserve preparing to reduce interest rates and the US economy showing few signs of a recession, banks stocks are set up for a strong rally, according to Wells Fargo & Co. analyst Mike Mayo.
Rate cuts should help net interest margins at many lenders, and indeed numerous large-cap banks are projecting higher net interest income and margins, partly based on lower deposit costs, the Wells Fargo analyst wrote in a note to clients Thursday. Banks have historically outperformed the S&P 500 by an estimated 10% from trough to peak during the quarter after a first interest rate cut, Mayo said.
“It is also possible that lower rates could spur more deposit creation and improve loan demand that has been very weak,” said Mayo, who’s been bullish on banks all year. Over the past 12 months, the KBW Bank Index is up over 40%, handily beating the S&P 500 Index’s 24% gain. The bank index closed Thursday up 0.6%, while the broader equities benchmark was little changed.
The recent rally has been bolstered by positive news regarding inflation, which prompted a rotation from technology stocks into companies that would benefit from the Fed reducing borrowing costs. May sees banks falling into that category.
However, Mayo’s bullish outlook comes with the caveat that the outperformance may not last long. If the economy achieves a soft landing, the momentum for bank stocks will fade after three months. And if a recession hits, the financial sector will actually underperform the S&P 500 over the next year.
(Updates chart and text with Thursday’s closing performance)
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