Are bank stocks really no-brainer buys in a rising interest rate environment?

As investors rotate out of growth stocks, Andrew Mackie explores whether bank stocks are indeed safe havens.

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Since the global financial crisis in 2008, bank stocks have, for the most part, made poor investments. A decade-long low interest rate environment has squeezed their key financial metric — net interest margin (NIM) — to low single-digits. They have also been forced to comply with sweeping regulatory reforms aimed at shoring up the banking system. This has included the capital structure requirements within CET1 as well as the introduction of the bank levy.

The consequences of these financial requirements have effectively prevented banks from handing out a large chunk of their profits to shareholders in the form of dividends. Echoes of the nervousness that still exists in the banking system, were very much in evidence when Covid struck. At that time, the UK regulator ordered the banks to suspend dividends on fears that they could suffer catastrophic impairment losses.

Runaway inflation

With the inflation genie out of the bottle, central banks are now beginning to taper their purchase of financial assets and actively moving to raise interest rates. In response, Barclays, Lloyds and HSBC have all begun putting out positive vibes to investors providing estimates of increased net interest income in their annual results presentations last week.

Recently, a growing number of investors have been rotating out of US equities and into more safe-haven stocks, including banks. The January sell-off on the Nasdaq demonstrates this. But growth stocks have been performing poorly against value stocks for some time now.

However, not all value stocks are equal. The clear beneficiaries of a rising inflationary environment so far have been tangible assets. Glencore, a leading commodities trader, has seen its share price hit a 10-year high. BP and Shell have surged as oil hits $110 a barrel. Bank stocks, however, have only seen small rises.

Lessons from history

One has to go back 50 years to find a comparable macro set-up similar to today. In the early 1970s, we had the nifty fifty (the growth stocks of the day) that reached insane valuations. Set against this, was the backdrop of rising inflation. Then, the oil crisis struck and oil prices went up threefold leading to the bear market of 1973-74. In the ensuing meltdown, when the S&P 500 lost half its value, bank stocks got crushed. The only stocks that did well were precious metals and commodities.

Today, a whole array of growth stocks from the FAANGs, to software companies and unprofitable start-ups have reached valuations totally detached from their underlying fundamentals. We have rising energy and commodity prices due to a chronic underinvestment in the natural resources sector. And we have inflation building in the system.

In such an environment, if the S&P 500 falls anywhere near the amount it did back in 1973, do you think banks would perform well against such a backdrop? I don’t believe they would. They would get caught up in the ensuing sell-off too.

So, does that mean that I am selling my existing holdings in banks? No, because I bought shares in these companies at the pandemic lows and I, therefore, have a good margin of safety. But what it does mean, is that I will not be adding to my positions. Bank stocks are not safe-havens buys for me in the present environment.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Andrew Mackie owns Glencore, Barclays, HSBC Holdings, BP and Shell plc. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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