What happened

Shares of several financial stocks fell between 10% and 21% in August, according to data provided by S&P Global Market Intelligence. These included the large bank and brokerage firm Charles Schwab (NYSE:SCHW), which fell 11.5%, and investment firms State Street (NYSE:STT) and Franklin Resources (NYSE:BEN), which were down 11.7% and 19.5%, respectively.

The three companies were hardly alone in their August woes. Companies across the banking and financial services sector fell in August, thanks in particular to three big pieces of news. 

A young man in a business suit ducks in front of a chalkboard drawing of a broken arrow

Even top financial industry companies have underperformed this August. Image source: Getty Images.

Hit No. 1: The Fed lowers interest rates

If you look at the chart of the three stocks' August performance, you'll notice a common pattern:

BEN Chart

Data by YCharts.

There was a steep drop at the beginning of the month that started to ease off until another jolt hit shares on Aug. 13, and then there was a relatively flat period until another drop on Aug. 23. 

On the first of the month, the Federal Reserve Board of Governors had just announced the day before that it would be cutting the benchmark federal funds rate by 0.25%. Rate cuts tend to have an outsize effect on financial stocks: Broadly speaking, the lower interest rates fall, the less return investors can make on a variety of financial products. This cuts into margins and profits.

An interest rate cut also sends a message about the state of the economy. Federal Reserve Chair Jerome Powell was adamant that the move was not in response to political pressure from the White House, and that it reflected a need to goose the economy to keep it chugging along. The fact that 10 of 12 Fed board members thought the economy -- previously seen as fairly strong -- needed a boost was troubling to many, who worried that a recession might be on the horizon. 

Hit No. 2: The yield curve inverts

Naturally, most stocks do badly during a recession, so investors in financial stocks aren't alone in wanting to avoid one. But recessions can be particularly hard on financial stocks. For investment advisors or managers, a recession means not only underperforming investments, but fewer people with money to invest signing up as clients and, potentially, existing clients getting spooked into exiting the market by falling stock prices.

Fears of such a recession intensified on Aug. 13, when the yield on the two-year U.S. Treasury note exceeded the yield on the benchmark 10-year U.S. Treasury note, meaning the short-term notes were yielding more than their longer-term cousins. Usually, longer-term investments offer higher yields, since they tie up one's assets for a longer time. 

An inverted yield curve such as this one is widely seen as a potential precursor to a recession, and that caused stocks to fall across the board, with the S&P 500 sinking 2.9%. Investment firms -- including State Street and Franklin Resources -- generally fared a bit worse than the overall market. State Street's shares fell 3.6% while Franklin's were down 5.4%. There were several other investment specialists whose shares fell more than the S&P. Schwab fared relatively well, falling 2.9%, in line with the S&P 500. 

Hit No. 3: The trade war intensifies

On the morning of Aug. 23, China announced it was increasing tariffs on $75 billion of U.S. goods, including a reinstatement of 25% tariffs on U.S.-manufactured cars. That afternoon, President Trump tweeted that he would be increasing tariffs on $550 billion of Chinese goods. The markets reeled, and the S&P 500 fell 2.6%. Once again, many banks and investment companies saw their stocks fall by a bit more, as escalating trade tensions elevated concerns about a potential recession. Shares of Franklin Resources and Charles Schwab fell by 3.4%. 

Hovering in the background of these three big hits was the fear that the U.S. economy was indeed slowing down, making it more likely that the Fed would implement additional rate cuts. The Brexit debate in Britain was also heating up, triggering fears of additional economic turmoil in the U.K. and Europe. 

There wasn't really one big issue or event that caused the financial stocks to underperform the market so badly in August, but a series of small events each resulted in incremental weakness that added up to double-digit declines.

Now what

It's a tricky time to be investing in financial stocks. As a group, they've done worse than the market so far this year. Additional interest rate cuts may be partially priced in but could also send the stocks further downward. If one thing is certain, it's that there's going to be further uncertainty as the trade war drags on and recession fears intensify. 

Some financial stocks -- particularly many banks -- have seen their valuations tumble to the point that this looks like a long-term buying opportunity. Indeed, Schwab is currently priced at 15.7 times earnings, which is near a 10-year low for the customer-friendly company. While this hasn't been true for all investment firms, Franklin and State Street are also at or near their 10-year earnings multiple lows -- at 10.4 and 10.5, respectively. 

Expect a lot of volatility and risk in the short term if you decide to buy in, but for long-term investors, it could be a decent time to go bargain shopping in the financial sector.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.