Rate cuts plus soft landing should see bank stocks outperform, says Wells Fargo

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Wells Fargo analysts believe that bank stocks are poised to outperform in the event of a soft landing combined with anticipated rate cuts, according to a recent note.

In a note to clients on Thursday, the firm emphasizes that historically, rate cuts without a recession have been favorable for bank stocks, particularly in the short term.

"Rate cuts with no recession (1995, 1998, 2019) result in bank stocks rallying," Wells Fargo wrote.

Analysts observed that in previous cycles where the Federal Reserve cut rates without triggering a recession, banks initially saw a short-lived decline of around 6% over one to two weeks.

However, they note that this dip was typically followed by a significant rally, with bank stocks rising about 21% from their post-cut lows.

Wells Fargo also pointed out that during these soft landing scenarios, banks outperformed the S&P 500 by nearly 10% in the quarter following the first rate cut.

The next Fed meeting on September 17-18 could be pivotal, as it may set the stage for this pattern to repeat.

On the other hand, Wells Fargo warned that if the rate cuts are accompanied by a recession, the outlook for banks would be less favorable.

Analysts explain that in past instances such as 1989, 2001, and 2007, bank stocks not only declined modestly after the first rate cut but continued to underperform throughout the following quarter.

In these cases, banks lagged behind the S&P 500 by an estimated 4%.

Despite the potential for short-term gains, Wells Fargo cautions investors that the window for outperformance is typically brief.

"In 7 out of 8 rate cut cycles, banks underperformed the S&P 500 in the period from 3 months after the first rate cut to 12 months after the first rate cut," analysts highlighted. As such, investors may need to act quickly to capitalize on the initial boost before the momentum fades.