The SPDR S&P Bank ETF (NYSEArca: KBE) is higher by 26.51% year-to-date, an arguably surprising rally when considering it was accrued against the backdrop of three interest rate cuts by the Federal Reserve. Some market observers believe bank stocks and funds, such as KBE, can continue the good times in 2020.

Banks typically make their money off the difference between long-term loans and deposits. With yields rising on later-dated debt, banks will be able to set more lucrative interest rates on loans and go back to generating greater profits on core businesses.

KBE follows the S&P Banks Select Industry Index, which seeks “to provide exposure to the bank segment of the S&P TMI, which comprises the following sub-industries: asset management & custody banks, diversified banks, regional banks, other diversified financial services, and thrifts & mortgage finance sub-industries,” according to State Street.

“Gerard Cassidy, managing director at RBC Capital Markets, thinks the rally in bank stocks should persist into 2020 riding on multiple tailwinds, including a strong economic backdrop, increased merger and acquisition activities, and a supportive regulatory environment,” reports Evie Liu for Barron’s.

Call On KBE

Traders previously warned banks could face pressure as tepid market volatility could have contributed to more muted trading desk activity. Furthermore, the Federal Reserve has signaled its intentions to cut interest rates, which would further hurt the banking industry’s ability to generate profits from lending. However, third-quarter earnings from the sector were mostly steady, if not surprisingly strong.

Buoyant economic growth supports the case for KBE.

“A stronger economy means more companies and individuals are likely to borrow from banks to invest or purchase,” according to Barron’s. “A steepening yield curve means banks can charge more from long-term loans than they pay for short-term debt, and the wider gap between the two rates would boost their margins. Cassidy expects the economic strength to continue in 2020 and yield curve to keep steepening, which should drive banks’ loan revenue up by about 3.8% from the previous year.”

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While mortgage banking and cheap valuations could provide some support to U.S. bank, the sector performance largely depends on executive position credit conditions, the outlook for loan growth and their ability to cut deposit costs.

“Despite this year’s rally, bank stocks are still trading at relatively cheap valuations. According to Cassidy, the S&P 500 bank index now trades at 11.8 times forward 12-month earnings and 1.4 times book value,” reports Barron’s.

For more information on the financial sector, visit our financial category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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