Bank Stock Declines Indicate Federal Reserve Tightened Too Soon

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Includes: BA, C, IYF, JPM, WFC
by: ModernMonetaryTheorist

Summary

The Federal Reserve recently raised interest rates to "normalize" monetary policy. The Federal Reserve appears to be tightening monetary policy in a too soft economy.

Personal Income and Spending reports show what the latest unemployment report showed, weak wage gains. The spending side of the economy is also soft.

Bank stocks have under-performed the overall market by a wide margin since the Federal Reserve increased rates. Banks are very sensitive to monetary policy and investors are voting no confidence.

The Federal Reserve raised interest rates on December 16, 2015, from a range of .00-.25% to a range of .25-.50%. The Federal Reserve has expressed a desire to normalize interest rates for the last couple of years and finally pulled the trigger in December. The Fed has ignored most economic signals indicating economic weakness and has focused on the unemployment report which has indicated growth in employment. But more jobs doesn't mean better jobs.

The latest monthly Personal Income and Outlays report was quite weak according to Bloomberg. They state "The outlook for the consumer has buckled, at least a bit following a surprisingly weak personal income and spending report for February. Income rose a soft 0.2 percent with wages & salaries slipping 0.1 percent. But the worst news comes from the spending part of the report, up only 0.1 percent and with January revised sharply lower, now also at 0.1 percent vs. an initial jump of 0.5 percent."

Since then, the KBW NASDAQ Bank Index (BKX) has declined by 15.7% versus a decline in the Dow Jones Industrial Index of less than 1% over the same time frame. The Index is compiled, maintained and calculated by Keefe, Bruyette & Woods, Inc. and is composed of approximately 24 companies representing leading national money centers and regional banks or thrifts.

The following chart from Bloomberg Markets is a comparison of the KBW NASDAQ Bank Index to the Dow Jones Industrial Average over the last year:

Click to enlarge

Notice how the Bank Index has out-performed the Dow Jones over most of the last year. Then, soon after the Federal Reserve raised interest rates in mid-December, the bank index has swooned significantly versus the Dow Index. This is a clear vote of no confidence in Fed policy by investors, since banks represent the most directly impacted sector in the economy to Fed policy.

One of the big problems banks are facing is a lack of wage gains in employment. Not only does this limit future growth, it also raises potential losses in consumer loan portfolios as wages fail to keep up with increased debt payments. The banks with the largest credit card portfolios include Bank of America (NYSE:BA), Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM), and Citibank (NYSE:C).

Multiple commentators, including yours truly, have been commenting over the last year that the Federal Reserve's move to raise interest rates in the current economic environment was misguided. In January I wrote about the need for the Federal Reserve to reverse its misguided policy. Kristina Hooper just wrote about how The Fed Is Seeking Inflation. Based on the current outlook on slack in wage gains the Federal Reserve will need to be much more aggressive to reach their inflation target of 2%.

It looks like the Federal Reserve may finally be getting the message. In her speech today, Federal Reserve Chair Janet Yellen said "caution in further rate hikes is 'especially warranted' at the current time. Not only that, but the central bank has 'considerable scope' for further stimulus, if needed, she says."

A change in the direction of Federal Reserve policy will most directly impact the banks. Considering their poor performance since the Federal Reserve raised interest rates, any change in Fed policy could lead to a rally in bank stocks. Any rally could turn into a bull market if Chair Yellen changes the phrase the Fed has considerable scope for further stimulus, "if needed," into the phrase, "is needed."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.