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Regional banks look poised for more gains.
The economy is on the verge of a tipping point.
For the first time since 2020, the Federal Reserve is set to cut interest rates. Chair Jerome Powell believes inflation has cooled sufficiently and the central bank must now turn its attention to shoring up the labor market as the unemployment rate has risen by nearly a full percentage point since last year.
Over the next year or two, interest rates are likely to come down by two or three percentage points based on the Fed’s own projections, which should have a significant impact on the economy.
Interest rates will fall, which will lower mortgage rates, stimulating the housing market. Investors are likely to rotate back from bonds to dividend stocks, and borrowing costs for businesses will fall.
A number of stocks will benefit from interest rate cuts, but one sector looks especially poised to capitalize on it.
Image source: Getty Images.
Regional bank stocks could surge
Regional banks are among the most cyclical sectors on the stock market, even more so than their larger national bank peers.
That’s because regional banks are more sensitive to business growth and demand, interest rates, and defaults, among the other risks that come with banking.
Regional bank stocks plunged last March as the run on banks like Silicon Valley and Signature Bank caused a broader regional bank crisis. The sector has gradually recovered from that crisis and is trading slightly below pre-crisis levels.
If the Fed achieves the so-called “soft landing,” meaning bringing interest rates down without pushing the economy into a recession, regional banks are poised to be winners.
Lower rates, in and of themselves, have a mixed impact on bank results. They tend to lower net interest income, by naturally narrowing spreads between loan and deposits. However, lower interest rates also tend to act as a tailwind for the overall economy and for banks as they encourage borrowing and spending, driving demand for new loans, and there also to be fewer defaults in a healthier economy, which helps banks avoid losses on charge-offs or defaults.
What’s unique about the upcoming rate cuts is that it’s set to take place during a time of economic expansion rather than a recession, which is when rate cuts usually take place. The two most recent rounds of cuts occurred during the pandemic and the great financial crisis.
This time, however, the combination of rate cuts and a strengthening economy could form a strong tailwind for the banking sector. Investors seem to agree as bank stocks soared when Jerome Powell said that the central bank was ready to start cutting rates
1 ETF to take advantage of it
There’s nothing wrong with investing in individual regional banks, but there’s a lot to choose from in the industry, and parsing them can be difficult and time-consuming.
Since regional banks are subject to the same trends, investing in the regional bank ETF SPDR S&P Regional Banking ETF (BREAK 0.28%) makes more sense.
The ETF holds 141 stocks, and none makes up more than 2.5% of its holdings, though over a dozen stocks contribute at least 2% of the value of the ETF.
Among the top holdings in the fund are Western Alliance Bancorp, Valley National Bancorpand Columbia Banking System. The SPDR S&P Regional Banking ETF also offers an attractive valuation.
Currently, the ETF trades at a price-to-earnings ratio of just 10.2, a great value for a sector that’s likely to deliver growth as interest rates come down. Additionally, the fund currently offers a dividend yield of 2.7%, making it a solid bet for dividend investors.
While the ETF has recovered its losses from the regional banking crisis, the fund is still down 27% from its peak indicating substantial upside potential for the sector.
Why the SPDR S&P Regional Banking ETF is a buy
The combination of low unemployment, a rebound in the housing market, and falling interest rates could be a perfect combination for regional bank stocks.
Interest rate cuts will also mitigate losses on some ailing commercial real estate loans like the office subsector, but lower rates should encourage broader economic growth, helping to overcome those headwinds. There’s still some risk still in the sector, but investors are more than compensated for them at a P/E of 10.
While a number of stocks are likely to be winners in a falling-rate environment, the KRE ETF looks like one of the easiest ways to grow your portfolio through the end of the year and beyond.