Bank stocks typically rally when there are rate cuts without a recession, says Wells Fargo's Mayo

Following the Federal Reserve's recent rate cut, historical data from Wells Fargo indicates that bank stocks typically rally into and briefly after the first cut, with sustained outperformance, averaging 21% in soft landing scenarios, generally confined to the initial three months. Wells Fargo analyst Mike Mayo cautions that banks have historically underperformed the S&P 500 beyond this period, particularly if cuts precede a recession. Despite this, major bank stocks like Goldman Sachs and Morgan Stanley have already seen initial post-cut gains and significant outperformance against the S&P 500 over the last six months.

Analysis

Following the Federal Reserve's recent quarter-percentage-point rate cut, historical performance data for the banking sector presents a bifurcated outlook heavily dependent on the macroeconomic outcome. According to Wells Fargo research, bank stocks have historically rallied an average of 21% from their post-cut lows in soft-landing cycles such as 1995, 1998, and 2019. Conversely, cycles preceding a recession (1989, 2001, 2007) saw bank stocks weaken throughout the quarter. A crucial insight from analyst Mike Mayo is the short-term nature of this potential outperformance; in past cycles, any outperformance versus the S&P 500 was achieved within the first three months. Notably, banks underperformed the broader market in the period from 3 to 12 months after the first rate cut in 7 out of the last 8 cycles. While select names like Goldman Sachs, Morgan Stanley, and Bank of America have posted initial 1% gains post-decision, they have already significantly outpaced the S&P 500 over the last six months, with gains of 45%, 35%, and 25% respectively, suggesting some positive sentiment may already be priced in.

Key Decisions for Investors

• Consider a tactical, short-term long exposure to the banking sector to potentially capture a rally contingent on a soft-landing scenario, but be aware that significant recent outperformance may limit near-term upside.
• A clear exit strategy should be planned for within a three-month timeframe, as historical data shows a high probability of bank stocks underperforming the S&P 500 in the 3-to-12 months following the initial rate cut.
• Closely monitor leading economic indicators, as the viability of this trade is entirely dependent on avoiding a recession; signs of a downturn would be a strong signal to exit any long positions based on this historical pattern.