When Market Expectations Trump Reality: Regional Banks

Following President Donald Trump’s election victory in November, regional bank stocks aggressively rallied as investors cheered the possibility of a new banking boom during the Trump era. On the campaign trail, Trump repeatedly called for deregulation of banks and lower corporate tax rates, policies that would seemingly open the door for major earnings growth for banks.

In the first week following the election, shares of regional banks such as KeyCorp KEY, Huntington Bancshares Incorporated HBAN, Citizens Financial Group Inc CGF, Fifth Third Bancorp FITB and Zions Bancorp ZION rallied 14-20 percent. However, it didn’t take long for some traders and analysts to remember that there are never any sure things in Washington.

On November 16, Bernstein analyst Kevin Pierre downgraded Citizens Financial, Fifth Third, KeyCorp and Zions, noting that the huge move in bank shares had already priced in the full potential benefits of Trump’s policies.

Related Link: Mid-Cap US Banks Near Peak Valuations; Citizens, Fifth Third, KeyCorp, Zion Downgraded

In fact, investors are now starting to question the potential timetable for tax reform and deregulation. Trump and congressional Republicans have made clear that healthcare reform is a top priorty at the moment, and the process isn't going as smoothly as anticipated. Trump may not even have enough votes on Friday to get his healthcare bill through the Republican-controlled House of Representatives.

Still, with tax reform nowhere in sight, the five regional bank stocks mentioned above remain up 14-29 percent since the beginning of November. Even with elevated earnings expectations, the banks’ forward PE ratios are all up between 24 and 54 percent from where they were a year ago.

Deep value investor Tim Melvin said in December investors shouldn't buy banking stocks trading at more than 92 percent of their respective tangible book value, which makes it more difficult for investors to allocate new money to the financial sector.

Melvin said at that time many small banks either do a good job in building their businesses along with paying investors a solid dividend or buying back their own stock. However, small banks have found it difficult to operate given the regulatory environment that has resulted in some industry consolidation. Either one of those is a great outcome for investors who can buy a solid bank and hold on to shares for some time.

With rising interest rates, lower taxes and less government oversight, banks may very well soon be earning more income. However, a closer look at the numbers indicates the market may have jumped the gun a bit with the huge post-election rally.

In the past month, the Financial Select Sector SPDR Fund XLF is down 4.1 percent and the SPDR KBW Regional Banking (ETF) KRE is down 8.5 percent.