Does this sound familiar?
The rate of inflation was slowing along with spending by US consumers. So, the Fed cut interest rates by a quarter in July. It did it again in December — and again in January.
That was 1995 — and those interest rate cuts sparked the beginning of one of the best multiyear periods for banks in US history. An index broadly tracking the sector would finish the year up over 40%, outperforming the S&P 500 (GSCP). And that outperformance would hold for two more years.
Can 1995 happen again for the big banks? As it stands now, it might be a moonshot scenario for 2025 as the Fed contemplates rate cuts. But that hasn’t stopped Wall Street from thinking about that glorious year — and what it would take to see such a winning streak again.
So far, the industry is off to a decent start when it comes to chasing that dream.
This year, the same banking industry index (^BKX) is up more than 14%, while a regional bank-focused index is up 8%. True, both trail some major indexes. But an even wider financial sector index, the Financial Select Sector SPDR Fund (XLF), which has roughly a little less than a quarter of exposure to the country’s biggest banks, is up 19%.
“History isn’t likely to repeat, but it may rhyme,” Mike Mayo, a Wells Fargo analyst who covers the country’s largest banks, said of the 1995 comparison. Though Mayo isn’t counting on next year being as good as that mystical year, he does see similarities.
On the three occasions (1995, 1998, and 2019) where the Fed cut interest rates and a recession didn’t follow, bank stocks on average sold off initially after the first cut, then rallied several weeks after —outperforming the S&P 500, according to analysis from Wells Fargo Securities.
But a wider review of the past six rate-cutting cycles (including three that were followed by recessions) shows the industry’s outperformance doesn’t usually last long. Only in 1995 did banks rally more than the broader stock market for longer than three months after the first rate cut.
Back then, it wasn’t just monetary policy that lined up right for banks.
Rough start
The industry started the year off in rough shape. Major institutions failed: That included the municipality of Orange County, Calif., declaring bankruptcy in December of ’94 and British merchant bank Barings, which collapsed in February of 1995. Banks with big trading desks had taken serious losses from a bond market wipeout the year before — and commercial real estate lenders were still seeing loan losses from a crisis that began in the late ’80s.
Meanwhile, real US GDP even slipped below 1% over the first half of the year. And yields on the longer-term 10-year Treasury plunged by 250 basis points.
Yet, crucially, those longer-term yields remained higher than short-term notes. That allowed banks, which borrow at short-term rates and lend at long-term rates, to profit by a wider margin from the difference.
And it wasn’t just interest rates that sparked higher bank profits in 1995.
US bank regulation was also entering a period of loosening, starting with a federal law signed by then-President Bill Clinton the year before. That law eliminated restrictions that stopped banks from opening branches across state lines, setting the stage for a period of deregulation that would eventually give rise to the country’s mega-banks like Wells Fargo (WFC) and Bank of America (BAC).
Regulating like it’s 1995 again?
Without going too far, Wells Fargo’s Mayo said, “It looks like the regulatory pendulum may be swinging back that way.”
While bank regulation has tightened since the Trump administration, big banks have more recently grown bolder in confronting regulators over disagreements. The Supreme Court also struck down the so-called Chevron doctrine, which gave regulators deference in more legally ambiguous court disputes.
Last week, regulators also unveiled new bank capital rules that signaled a backpedal from what was initially a more stringent set of increases.
What is so different this time compared to ’95 is that the current shift in monetary policy follows one of the longest periods of low interest rates in US history. Along with the rush of deposits flooding into banks during the pandemic, that unusually long, and easy, period left many lenders poorly positioned when adjusting to significant rate increases, said Allen Puwalski, chief investment officer and co-portfolio manager at Cybiont Capital.
“There’s no argument that the falling rates are good for banks. I’m just not sure that it’s for the same reasons that it was in ’95,” Puwalski added.
For next year to be anywhere near as good as it was for banks 29 years ago, the Fed will first need to pull off the so-called soft landing scenario, managing to bring down inflation without causing an economic downturn. And even if it’s not going to look as good for banks as 1995, that is exactly what happened back then.
“There are plenty of things that could go wrong,” former Federal Reserve Bank of Boston president Eric Rosengren told Yahoo Finance. “But I think it’s a high enough probability that it’s still reasonable to talk about a soft landing.”
Dream — or fever dream?
For now, 2025 looks like a mixed bag when it comes to bank earnings. Lenders that benefited from high rates are likely to see less profits, while those that lagged are expecting a boost.
Even without a US recession, a repeat of 1995 would still require loan growth and the continued revival of investment banking.
At a Barclays conference last week, some bank executives, including Bank of America CEO Brian Moynihan and PNC (PNC) CEO Bill Demchak, reiterated their expectations for better earnings in 2025.
Others didn’t.
JPMorgan Chase (JPM) COO Daniel Pinto told investors that analysts are “a bit too optimistic” about how much the bank will earn in 2025.
“Over the course of the quarter, our credit challenges have intensified,” Russell Hutchinson, CFO of Ally Financial (ALLY), said of the bank’s retail auto business the same day.
Gerard Cassidy, a RBC Capital Markets analyst, expects banks to see higher revenues next year but also more credit problems.
“We do expect to see incrementally higher loan loss provisions in the next 12 months, in our view,” Cassidy added.
This much is clear: Though betting on banks having another 1995 next year may ultimately prove risky or foolish, the industry is shifting once again. For now, the arrows seem pointed in the right direction.
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto, and other areas in finance.
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