Q: I understand why my China-exposed tech stocks have been doing poorly, but why are banks getting hit so hard with the trade war uncertainty?
At first glance, it may seem like banks shouldn’t be affected by trade issues. After all, most U.S. banks have a negligible amount of direct exposure to China or Mexico, where the major tariff issues are focused.
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However, the financial sector has actually underperformed the already weak stock market recently. There are two good reasons for this.
First, bank profits generally rise when interest rates do, and fall when yields drop. After all, higher rates mean that banks can charge more for loans to customers. In May alone, the 10-year Treasury yield (a good benchmark for banks) fell by more than 40 basis points, which could hurt bank profits in the short run.
Second, banks rely on a strong economy and consumer confidence to grow profits. Think about it — no matter how high a bank’s profit margin is, if loan volume is cut in half, it isn’t going to be making much money.
Most experts agree that tariffs will lead to higher costs for U.S. consumers on many products, which leads to less discretionary income and lower confidence to make large purchases like cars and homes, which are normally financed through banks.
The bottom line is that falling interest rates and worries about lower consumer confidence and economic weakness are a bad combination for banks, which is why we’ve seen dismal performance from most bank stocks despite little direct exposure to the trade war.
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