Financial Sector Sickness

The S&P 500 was last near its all-time highs in mid-July 2015. Since then, what do you think has been the worst-performing sector of the U.S. stock market?

You may have guessed the energy sector, which has continued to be pummeled due to the collapse in the price of crude oil. However, the financials have been an even bigger disaster.

As I said in October 2015, the U.S. banks are better capitalized than their global counterparts, but that didn’t mean their stocks were good investments.

The chart below ranks the S&P 500 sector total returns since July 20, 2015:

S&P 500 Sector Total Returns: 7/20/2015 to 2/18/2016

It’s not much of a surprise that the utilities, which are defensive in nature, have been the best-performing sector since the stock market swoon began.

On the other hand, the 16.6% decline for the financials is downright shocking.

Here are two of the main factors at play:

Interest Rates: A flattening yield curve is generally bad for commercial banks. Declining long-term yields limit a bank’s opportunity to profit from lending. Also, the proliferation of negative interest rate policies (NIRP) around the world may be weighing on the minds of bank share investors.

European Contagion: The share prices of several big European banks, such as Deutsche Bank AG (DB) and Credit Suisse Group AG (CS), are hovering around levels last seen during the global financial crisis. Europe has a massive, non-performing loan problem. Since large, global banks are highly interconnected, the U.S. banks have fallen in sympathy.

Aside from these immediate concerns, there are general issues holding the financials back.

For example, the investment banks, such as Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), have been neutered. The Volker Rule within the Dodd-Frank Act prohibits them from engaging in proprietary trading.

The Dodd-Frank legislation has also been seen by many as making the “too big to fail” banks even larger by imposing onerous regulatory and compliance requirements on smaller banks.