As the shock of last week’s Brexit vote begins to fade and major indices begin to bounce back, one sector appears particularly vulnerable for some short-term pain: global bank stocks.
The stumble in major finanical markets was significant: London-based Barclays (ticker: BCS) and Royal Bank of Scotland Group (RBS) stock took 37 percent haircuts, while Deutsche Bank (DB) shares slumped 22 percent.
Across the pond, shares of U.S. banks weren’t quite so affected — but it still wasn’t pretty. In the fateful two-day selloff, Goldman Sachs Group (GS) shares fell 8.6 percent, JPMorgan & Chase (JPM) fell 10 percent, and Bank of America Corp. (BAC) lost 13.2 percent.
Financial experts are predicting volatility as the U.K. begins the long process of exiting the EU and forging new trade agreements with European states. The value of the British pound has fallen to 31-year lows, and some are predicting that the U.S. dollar could soon equal the pound.
That’s good news for consumers who rely on the power of the dollar — vacation to London, anyone? — but it makes it even more unlikely that the Federal Reserve will be able to carry through with its plan for a series of measured interest rate increases this year.
Fed Chair Janet Yellen moved in December to raise interest rates for the first time in nearly 10 years. It was seen as the first of many such hikes to come, as the U.S. eases itself out of an era characterized by dovish policies, capital infusions and cheap money.
[Read: How Britain Could Undo the Brexit.]
But the Brexit (and the heavy dose of risk that comes with it) has put those ambitions on the back burner — and that’s a lousy omen for banks and bank stocks, which have more room to profit when rates are on the rise.
A stronger dollar makes U.S. exports less attractive to foreign trade partners, says Eric Lascelles, chief economist at RBC Global Asset Management. “Prosaically you could say that when scary things happen the dollar rises, and a stronger dollar is actually another negative for U.S. growth,” he says.
A strong greenback also “holds down inflation and keeps the Fed from having to raise rates for both of those reasons,” he says.
Throw in the political and economic uncertainty as well as increased investor caution and you’ve got yourself a textbook scenario for when not to raise rates. And that’s where London’s woes magically travel across the pond.
Chris Gaffney, president of World Markets at EverBank, says that the business model for banks becomes more untenable as rates stay lower for longer. “Banks make money in spread, in the difference between the rate at which they loan money out to businesses and individuals and the rate at which they have to pay businesses and individuals on their deposits,” he says. “In a low-rate or negative interest rate environment, there is no spread.”
[Read: Reverse Mortgages Aren’t For Everyone.]
But lower rates aren’t the only reason markets have hammered large U.S. multinational banks like JPMorgan and Bank of America.
Additional costs could pile up for U.S. banks because global financial institutions, “in many cases have significant European and London operations, and whether those operations can continue in London is now an open question,” Lascelles says.
Packing up and moving entire operations from London to Brussels or Frankfurt or Dublin, after all, isn’t cheap. There’s no playbook for something like this.
“I’ve been in the markets 30-plus years, and this and Lehman in 2008 are the two events that really come to mind when you think about market-moving events,” Gaffney says.
That’s not to say that the Brexit fallout and the resultant ultra-low rate environment is void of opportunities for individual investors. Quite the opposite. “Stocks that have consistently paid good dividends are going to be in demand, because there’s just no interest available elsewhere,” Gaffney says.
Thankfully, there are still plenty of those to choose from. Stocks like Chevron Corp. (CVX), Colgate-Palmolive Co. (CL), Coca-Cola (KO), Procter & Gamble (PG) and Consolidated Edison (ED) have all dished out dividends annually for more than 100 years.
In the meantime, while the Brexit certainly hasn’t made life any easier for banking stocks, that doesn’t mean it’s time to karate chop the shiny red “sell” button and ditch all your exposure to the financial sector.
Scott Hanson, certified financial planner and a senior partner and co-founder of Hanson McClain Advisors, a California-based financial advising firm, recommends taking a more tempered approach.
“From an investor’s standpoint, they really need to take a good look at their allocations right now, and if they find that they’re overweighted in financials they need to question why that is, and I think for most investors they’d want to reduce their allocation so that they’re not overweighted.”
[See: 11 Great Investing Tips for Women.]
Given the recent swift pullback in financials, it looks like Wall Street had the same idea.
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Bank Stocks Will Suffer After Brexit Vote originally appeared on usnews.com
