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2 Ways the Trade War Hurts Banks

By Motley Fool Staff – Jun 7, 2019 at 10:49AM

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Most banks don't have much direct exposure to tariff-prone countries, so why have they underperformed?

Bank stocks have been one of the worst-performing parts of the stock market since the trade war heated up over the past month or so, despite little direct exposure to tariff-prone countries.

In this Industry Focus: Financials clip, host Jason Moser and contributor Matt Frankel, CFP, discuss the two main ways banks could be impacted by the trade tensions, and what it could mean for investors.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on June 3, 2019.

Jason Moser: We wanted to really dig into this first on the show today because it's been brought more to the forefront here lately as the headlines continue to bat it around -- it's this trade war. It's the trade war and how this is impacting not only the headlines on a day-to-day basis, but really how it has played out over the financials sector here for the better part of the year.

You were talking about this before we started taping. Really, it plays out in two different ways here. Tell the listeners what you were telling me.

Matt Frankel: The trade war's been going on for about a year now, when you think about when Trump first started threatening all the tariffs on China. But I'd say it'd be fair to say it really just heated up in the past month or so. China tariffs popped up to 25%, and the recent ones with the Mexico tariff threat. Over the past month, banks have actually underperformed the market, which hasn't done that well itself, by about 2%, which is significant. Banks are down about 7% or 8% this month alone in May.

There are two things that investors need to know. One is that banks are very interest rate-sensitive. We've talked on the show before about how as interest rates rise, particularly long-term interest rates, banks make more money because they profit from the spread between what they're paying for deposits and what they're getting for loans. Say, when you go to buy a car, the bank loans you money. Now they're charging you, say, 4%, and they're paying a depositor 0.5%. That difference is their profit. So, when rates go up, they make more money. Conversely, when rates go down, they can make less money. That's what we've seen play out recently. In the past month alone, the 10-year Treasury has dropped from 2.54% to 2.11% yield. So there's a lot of fears that these falling rates will cut into bank profits, kind of how a year ago, we were talking about how rising rates were causing investors to be optimistic.

Moser: Well, you and I were talking a lot about that because a lot of these banks started trading at very attractive valuations given that potential tailwind. It sounds that tailwind is maybe going to be on hold for now.

Frankel: Right. Everyone thought the Fed would raise rates a few more times, myself included. That was one of my bold predictions that I can pretty much say at this point I got wrong.

Moser: [laughs] Well, there's nothing like getting out there and embracing the mistakes, Matt. Learning from them!

Frankel: Who could have predicted tariffs on Mexico? I don't know too many people who thought that was coming.

Moser: Yeah, it's a really weird time. It does feel, if you look at President Trump's history before he ever became president, he's always been very fond of deal-making. I can't help but wonder if maybe this isn't a bunch of that going on. There's no question that tariffs, by their very definition, raise the cost of doing business for virtually everyone. I think anybody can see that. Hopefully this is just some temporary bluster that eventually blows over.

Frankel: Right. Your point brings me to my second point, which is that banks thrive on having a strong economy, consumer confidence in particular. A bank could have all the profit margin in the world, but if consumers aren't taking out loans to buy things, it doesn't really matter. Tariffs not only make the cost of goods higher for American consumers, but leave less disposable income in people's pockets, more uncertainty, which makes people less willing to go out and buy homes, buy cars, take out personal loans, use their credit cards, things that, that banks depend on for their profits. So, we might actually see some assets fall on bank's balance sheets as people take out fewer loans, especially if all this continues and the China tariffs go to the rest of the Chinese goods, I think it's another $300 billion or so, and the Mexico tariffs kick in. You might see a big lack of consumer confidence, which could be really bad for banks.

Moser: Sure. Again, I think this goes back to the advantages of being able to take that longer-term perspective. It's not like we're sticking our heads in the sand and saying, "These problems don't exist, blah, blah, blah. If I can't see you, you can't see me!" It's one of those situations where we may see some very attractive valuations for some of these really well-run banks that, if you can take that three- to five-year outlook and say, "You know what? This is money that I can part with for a little while," it does look like there are going to be some opportunities that come from this.

Frankel: Oh, absolutely! It's bargain-hunting time. My one to watch today is going to have something to do with that, just a little preview. The one big takeaway is that few banks have a lot of direct exposure to China or Mexico or any of these affected countries. The majority of companies that have a lot of Chinese exposure are tech companies. The majority of companies that have a lot of exposure to Mexico are the auto industry, energy. Financials have very little direct exposure. They have some, but not a needle-moving amount. It's all this indirect results of the trade war that are really going to hit the banking sector. But like you said, this is a great time to go shopping.

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