Market Overview

Markets Sell Off Amid Rising Recession, Yield Curve Concerns; Bank Stocks Hit Hard

Markets Sell Off Amid Rising Recession, Yield Curve Concerns; Bank Stocks Hit Hard

U.S. stocks took a beating Tuesday after the yield on five-year Treasury notes dipped below the yield on three-year and two-year Treasury notes for the first time since 2007. Bank stocks were hit particularly hard, as fears that an inverted yield curve could be signalling a U.S. recession and a difficult earnings environment for financial institutions.

The S&P 500 dropped 3.1 percent (87 points), the Dow Jones Industrial Average dropped 3 percent (791 points) and the PowerShares QQQ Trust, Series 1 (NASDAQ: QQQ) dropped 3.8 percent as investors worried about the possibility of a U.S. recession.

Each of the nine U.S. recessions that have occurred since 1955 came between six months and 24 months after an inversion in the yield curve of two-year and 10-year Treasury yields, according to the San Francisco Fed.

Related Link: What A Yield Curve Inversion Means For Traders

Financials Hammered

Bank investors were hit particularly hard Tuesday. A steeper yield curve helps banks boost their net interest margins, a measure of the difference between the interest rates they pay out on deposits and the ones they charge on loans. Here’s a look at big U.S. bank stocks traded:

  • Financial Select Sector SPDR Fund (NYSE: XLF) was down 4.3 percent.
  • Bank of America Corp (NYSE: BAC) fell 5.8 percent.
  • Citigroup Inc (NYSE: C) fell 4.8 percent.
  • JPMorgan Chase & Co. (NYSE: JPM) fell 4.2 percent.
  • Wells Fargo & Co (NYSE: WFC) fell 4.4 percent.
  • Deutsche Bank AG (NYSE: DB) fell 3.6 percent.
  • Morgans Stanley (NYSE: MS) fell 5.2 percent.

Investor Sentiment

Aside from Treasury yields, Wall Street analysts have been watching other indicators to gauge the health of the bull market as well.

Investor sentiment, a historically reliable contrarian indicator for the stock market, has been extremely high lately, which Bank of America's Savita Subramanian says is a bearish sign. Bank of America’s Sell Side Indicator hit a seven-year high in November, suggesting investors expect at least 10 percent returns over the next year.

“Whereas this model is based on comparing today’s sentiment levels vs. the long-term average, we have found some evidence that sell signals have higher efficacy relative to shorter histories, which would imply a more bearish outlook,” Subramanian wrote in a Monday note.

Bullish Signals

LPL Financial analyst John Lynch said there are still plenty of bullish indicators for stocks as well. He says U.S. GDP growth of nearly 4 percent over the past two quarters and 28 percent earnings growth from the S&P 500 in the third quarter suggest underlying economic fundamentals are strong. In addition, Lynch said the recent pullback has brought the S&P 500’s PE ratio down to just 15.7, a relatively attractive historical valuation.

“As always, there are risks, but we continue to believe our year-end fair value target range for the S&P 500 of 2900–3000 is achievable” Lynch wrote Monday.

Tuesday’s sell-off brought the S&P 500’s year-to-date return down to just 2 percent with less than four weeks remaining in the year.

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