Do bank stocks have a business cycle? | Motley Fool

Cyclical stocks are issued by companies whose business and stock prices tend to follow business cycles. They typically perform very well during periods of economic expansion, but they typically perform poorly during recessions as sales decline.

Automobile manufacturers are a good example of a type of company that is prone to business cycles. When a recession occurs, sales decline because consumers can wait longer to purchase new cars. Most discretionary retailers, such as airlines, hotels, restaurants, and apparel companies, are also cyclical. After all, a strong economy means more people can fly, stay in hotels, eat at restaurants, and splurge on new clothes.

The opposite of cyclical stocks is known as defensive stocks. These are stocks of companies that tend to perform similarly in terms of sales and profitability, regardless of economic conditions.

In this article, we look at the banking industry and whether bank stocks are cyclical investments.

Do bank stocks have a business cycle?

The short answer is yes. Bank stocks are typically affected by recessions for several reasons.

First, interest rates tend to fall during recessions. Since banks' main business model is to lend money and make profits, lower interest rates tend to lead to lower profits. For example, if your bank's average car loan interest rate is 5%, you'll make significantly more money than if your bank's average interest rate is 3%, all other things being equal.

Second, and more importantly, unemployment rates tend to rise during recessions, putting more consumers into financial hardship. During economic downturns, consumers often have difficulty paying their bills, which can lead to a spike in banks' loan losses.

But the longer answer is that it varies from bank to bank. Consumer banking (accepting deposits and lending money) is highly cyclical, and this is especially true for banks that specialize in riskier forms of lending, such as credit cards. On the other hand, investment banking Better As a result, banks with large investment banking operations tend to be able to maintain fairly high profits. for example, goldman sachs (G.S. 3.01%), which focuses on investment banking, achieved record high quarterly profits. Until now During the COVID-19 pandemic.

Bank stocks in an inflationary environment

It's also worth addressing how inflation and rising interest rates affect bank stocks, given that inflation has recently reached a 40-year high. These economic forces can be both good and bad.

On the positive side, high inflation rates mean average loan amounts tend to increase because goods and services become more expensive. In other words, all other things being equal, if vehicle prices rise by 10%, the amount of bank car loans should rise as well. Banks also make money on interest on loans, so higher interest rates usually lead to higher margins.

On the downside, high inflation and rising interest rates could lead to a slowdown in consumer spending. People tend to think twice about buying a home when mortgage rates are 6% versus his 3%, or when the average purchase cost is 20% higher than before. Additionally, as interest rates and costs rise, more people may have difficulty paying their bills and loan defaults may increase. In other words, simply put, Several Inflation and higher interest rates are good for banks, but too much can reduce loan volumes and cause defaults to skyrocket.

3 Cyclical bank stocks

With that in mind, here are three cyclical bank stocks. This means that although these banks are quite recession-prone, they tend to perform very well during good times.

1. Capital One Financial

capital one financial (C.O.F. 3.0%) is a regional, full-service consumer bank with an extensive branch network and most types of loan products. However, because Capital One specializes in credit card lending (nearly half of its loan portfolio), its business is highly cyclical.

In good times, tons Money earned through credit card financing. The average interest rate on credit cards is around 16%, so you can expect big profits. However, credit card default rates tend to be relatively high (4% to 5% charge-off rates are common even when the economy is strong), and default rates can skyrocket when the economy worsens.

2. Wells Fargo

wells fargo (W.F.C. 1.71%) is a member of the so-called “Big Four” U.S. banks; the others are american bank (BAC 2.43%), JP Morgan Chase (J.P.M. 2.24%), and citygroup (C 3.17%). Wells Fargo is the only company in this group without a significant investment banking business that helps it stay profitable in a time of rising unemployment and low interest rates. That's the main reason Wells Fargo's stock price fell more than other large banks when the coronavirus pandemic sent the U.S. economy into recession.

3. American Express

most people think american express (AXP 1.78%) Same as credit card networks, but different from. visa (V 1.42%) and master Card (Ma 1.14%), American Express also acts as a bank. Visa and Mastercard partner with banks (like Capital One) to lend money to consumers, while American Express is a “closed-loop” payment network. In other words, the company processes payments. and We provide our own financing to our customers.

American Express's cyclicality is somewhat mitigated by its generally affluent customer base, history of smart lending, and reliable, profitable payments network. However, American Express's heavy reliance on credit card lending makes it a highly cyclical bank stock.

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