Bank stocks traded broadly, and in many cases sharply lower, as the spread between yields on 2-year and 10-year Treasurys briefly turned negative for the first time since the financial crisis, fueling fears that a credit crunch and recession were looming.
The SPDR Financial Select Sector exchange-traded fund XLF, -3.28% sank 3.6%, with all 68 equity components losing ground. Within the subsectors, the SPDR S&P Bank KBE, -3.10% slumped 3.5% with all 90 components falling and the SPDR Regional Bank ETF KRE, -2.96% shed 3.3% will all 122 components declining.
The selloff comes as the S&P 500 index SPX, -2.55% dropped 2.9% and the Dow Jones Industrial Average DJIA, -2.61% tumbled 749 points, or 2.9%. Financials were the third-highest weighted sector in both indexes, with a 13.2% weighting in the S&P 500 and a 15.3% weighting in the Dow.
An inverted yield curve refers to when yields on shorter-term Treasury notes cross below longer-term Treasury yields. One of the most closely watched yield curve measures is the 2s-10s spread, as inversions have very often preceded recessions, as it indicates that monetary policy and financial conditions are too tight to support economic growth.
See Bond Report: 2-year/10-year Treasury curve inverts, triggering bond-market recession indicator.
For banks, an inverted curve can hurt earnings and act as a drag on lending, as the usual practice of taking on shorter-term liabilities to fund longer-term assets, like loans, can start costing banks money.
John Lynch, chief investment strategist for LPL Financial, said the yield curve inversion “sends an important signal” to the Federal Reserve. “U.S. monetary policy is clearly still too tight, even after last month’s 25 basis point (0.25%) rate cut, given trade uncertainty and signs of slowing global growth,” Lynch wrote in a note to clients.
Also read: Fed cuts interest rates by quarter point, but rules out significant easing.
While Lynch said that he’s not convinced a recession is imminent, given that recent data has showed that the U.S. economy is on “solid” footing, he acknowledged that “recessions can be self-fulfilling prophecies of market sentiment,” and investors should take that risk seriously.
See related: The U.S. Treasury 2-10 year yield curve inverted and that means stocks are on ‘borrowed time,’ says BAML.
Among individual bank stocks, Citigroup Inc. C, -5.21% dropped 5.5% toward a 4 1/2-month low, and was the biggest decliner in bank ETF. Among other more-active stocks, Bank of America Corp. BAC, -4.83% fell 5.0%, JPMorgan Chase & Co. JPM, -4.11% gave up 4.4%, Wells Fargo & Co. WFC, -3.85% shed 4.2% and KeyCorp KEY, -2.52% slid 3.5%.
Elsewhere, shares of Regions Financial Corp. RF, -3.99% lost 4.9%, Goldman Sachs Group Inc. GS, -3.99% fell 4.3%, Morgan Stanley MS, -3.67% declined 4.0% and Charles Schwab Corp. SCHW, -1.83% was down 3.1%.
If there is a bright side, the weakness in the financial sector could result in more merger activity for banks, according analyst Jennifer Demba at SunTrust Robinson Humphrey.
The three banks Demba highlighted as having “significant franchise value” are Regions Financial, Synovus Financial Corp. SNV, -2.45% and Ameris Bancorp. ABCB, -4.16%