Bank stocks in the U.S. have more than tripled in value since the bull market began over four years ago. But if history is any guide, they're about to reverse course as the Federal Reserve prepares to pull back on its monetary stimulus programs.
Financial stocks are the "single worst performers" during stock market corrections that are caused by shifts toward tighter Federal Reserve policies, according to Barry Knapp, chief investment strategist at Barclays.
Last week, Fed Chief Ben Bernanke laid out the details about when and how quantitative easing would end.
The stock and bond markets have sold off sharply. Knapp said the pullback is likely to continue as investors adjust to the move towards more normal Fed monetary policy. And he believes history will repeat itself. Banks should suffer the most.
Ever since Bernanke first hinted last month that the Fed may trim back on its bond purchase program, Citigroup and Bank of America are down about 10% while the broader market is off about 4%.
Knapp analyzed the performance of the broader market and individual sectors during the most recent periods when the Fed raised interest rates: 1983, 1994 and 2004. He noted that financials consistently lagged the broader market.
On average, financial stocks lose about 9% during Fed-induced corrections, about 1.5 percentage points more than the broader market.
It makes sense for bank stocks to fall under severe pressure if the Fed is shifting its policy. After all, they have outperformed the overall market by such a wide margin. But the main reason banks get hit the hardest is because their business is "clearly sensitive to interest rates," said Knapp.
Although Bernanke has stressed that the Fed is likely to keep short-term rates low until 2015, long-term bond yields have surged as investors anticipate a slowing of asset purchases by the Fed. So Fed tapering is being viewed by investors as a form of tightening.
That's bad news because higher interest rates can lead to heavy losses in the bonds that the bank already holds.
