U.S. stocks staged a major turnaround in July, with bank stocks soaring 10% to achieve the best monthly performance of the year

According to the Zhitong Finance and Economics APP, after a year of industry uncertainty, US bank stocks have recently been soaring.

The KBW Bank Index rose nearly 10% in July, closing on Tuesday at its highest level since August 2022, despite a slight pullback on Wednesday. This is the best monthly gain for the index since December of last year. Regional banks performed even better, surging 19%, marking the strongest monthly performance since November 2016. More broadly, financial stocks were one of the best-performing sectors in the S&P 500 Index in July. In contrast, the Nasdaq Index, which mainly tracks technology stocks, fell by 0.75% in July.

KBW Bank Index hits highest level since 2022

Multiple positives driving the surge in US bank stocks

There are many reasons for the surge in bank stocks. The latest round of financial reports shows that the trend of slowing net interest income for banks is nearing a bottom. At the same time, positive news on combating inflation has prompted investors to shift from technology stocks to companies that will benefit from the Fed's rate cuts, with banks being the primary beneficiaries. In mid-July, bank stocks received a boost as the market bet on Donald Trump winning the US presidential election and ushering in a more relaxed regulatory environment.

Mike Mayo, an analyst at Wells Fargo who predicted a rebound in bank stocks this year, said, "Earnings, rates, and regulations have all changed. This is a macro and micro turning point that makes bank stocks look increasingly attractive."

After the conclusion of the Fed meeting on Wednesday, the KBW Bank Index fell while technology stocks surged. The index closed down 0.8% on Wednesday.

The rebound in July continued the momentum of US bank stocks rebounding from their lows. Previously, concerns about stricter regulations and declining loan profits had weighed on US bank stocks. The KBW Bank Index has lagged behind the S&P 500 Index for two years, and although large banks have outperformed smaller banks, the sector has only started to outperform the broader market this year.

In mid-July, US inflation data prompted investors to reallocate funds from large tech stocks to small caps and other underperforming sectors, with the KBW Regional Banking Index posting its best single-day performance in four months.

Regional bank stocks post best monthly performance since 2016

Optimism about regulation is on the rise. Fed Chair Jerome Powell stated in July that regulatory agencies are close to reaching an agreement on modifying bank capital plans, a move that would mark a major victory for Wall Street The possibility of Trump winning the November election has brought a brief boost to the stock market. Trump's potential return to the White House has increased people's hopes of relaxing regulations on industries such as banking. Despite the latest polls showing a rise in support for Democratic candidate Kamala Harris, who is currently neck and neck with former President Trump in key states, bank stocks continue to rise.

Scott Chronert, the US stock strategist at Citigroup, said, "Our view is that the valuation of banks was not challenging to begin with; they should be less affected by tariff proposals; and with the Federal Reserve shifting to a less hawkish stance, banks may benefit." "The relaxation of regulations has added an element to this industry, becoming a rather direct 'Trump trade'."

Powell stated at the Federal Reserve meeting on Wednesday that the Fed may cut rates as early as September, which could help banks start lowering deposit rates and alleviate concerns about credit deterioration in a high-interest-rate environment.

Jamie Cox, managing partner at Harris Financial Group, said, "Since the crisis in regional banks last year, bank stocks have been almost abandoned by the market. With the possibility of regulatory relaxation and the yield curve potentially steepening, bank stocks once again have investment value."

Amid changes in the macroeconomy, banks have also reported robust profits. In early July, a series of financial reports released by major US banks led Morgan Stanley analyst Betsy Graseck to favor the sector, stating that net interest income "turning from headwinds to tailwinds will be a key driver of positive operating leverage in the second half of this year and in 2025."

Several of Wall Street's largest banks have been rebounding this year, partly due to improvements in capital market activity. Shares of JPMorgan Chase (JPM.US) and Goldman Sachs Group (GS.US) have both hit record highs.

Graseck said, "We have been emphasizing the theme of the rebound in capital markets, a prospect that continues to be supported as trading and investment banking revenues for most of the banks we cover have exceeded widespread expectations."

Warning Signals Flashing

However, there are signs that the rally may have run its course. The relative strength index of the KBW Bank Index has been hovering in overbought territory for several weeks.

Bank stocks show overbought signals

Baird analyst David George downgraded regional bank stocks in July, in part because he believes the industry's upside potential is limited, and the "Trump trade" is meaningless in this election cycle.

"Given that most bank stocks have hit 52-week highs, and market sentiment has seen the largest reversal in history, our valuation framework and cyclical thought process indicate limited upside for most banks," the analyst said. "Furthermore, we believe that a replay of the Trump trade makes no sense this time around ”