Bank Stocks, Interest Rates, And Business Cycles. Not That Obvious


Bank stocks are sensitive to interest rates.

Interest rates are sensitive to the strength of the business cycle.

The attractiveness of bank stocks depends on the trend of the business cycle.

Stocks of financial companies (XLF), banks (KBXB), and regional banks (KBWR) have been strong in the past several months. From September 23, 2020 to March 19, 2021, they appreciated +48%, +76%, and +112% respectively while the S&P 500 (SPY) rose only +22%. During the same period yields on the 10-year Treasury bonds jumped +111%.

Wall Street applauded the performance of the bank stocks and decided the reason was the sharp rise in yields. The explanation for the performance of the bank stocks is more subtle.

Yields rise because business need to borrow money and the need to borrow money is closely related to the need to invest in new production facilities to increase output and replenish inventories.

Since March 2020, the inventory to sales ratio has been declining quite sharply. As I discussed in detail in my article “A Strong Economy And Risks For The Markets”, a decline in the ratio means business is running short of inventory relative to the growth in demand.

As long as growth in demand is higher than the growth of inventory, as reflected by the decline in the inventory to sales ratio, business is forced to increase production. The increase in production must happen to replenish inventories. The alternative is a loss in sales.

To increase production businesses must hire workers. The outcome is faster growth in manufacturing employment. The business will have also to pay these workers, resulting in rising income. And most important, businesses will have to borrow money to finance capacity expansions, capacity improvements, and to pay for the production of goods and their delivery.

In the past, yields on 10-year Treasury bonds have moved in perfect synchronism with our business cycle indicators (see above chart). This indicator is updated in each issue of The Peter Dag Portfolio Strategy and Management on (Complimentary subscription available to readers of this article.)

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