Bank Stocks Struggling as Interest Rates Rise

Bank stocks could muddle along in the next few months, as so-so enthusiasm among major asset managers and other generalist investors dampens inflows into the sector, analysts say.

Investors, rattled by a few regional bank failures in 2023, came back into the sector after President Donald Trump’s election in 2024, anticipating less stringent regulations, a rebound in M&A and strong economic growth.

But generalist investors — pension funds or big investors who don’t specialize in banks — didn’t jump in headfirst, analysts say, and they don’t seem poised to do so now.

“The generalist interest is still somewhat muted,” says Brian Foran, a bank analyst at Truist Securities, with some investors happy to wait until bank stocks eventually become a bargain.

The current picture for banks is by no means gloomy, Foran said, pointing to still-clean credit quality, decent loan growth and generally strong profitability. Investors, however, worry that higher interest rates could put bank borrowers under pressure and raise their deposit costs.

“Deposit competition picking up is definitely the number one thing holding generalists back,” Foran says.

The Federal Reserve raised short-term interest rates in mid-September, its first hike since 2023. Markets anticipate more Fed tightening, helping drive a surge in the 10-year U.S. Treasury yield from roughly 4.7% in August to 5.24% by late September.

Bank stocks have softened from their August highs, but they’ve still risen this year. The KRE, an exchange-traded fund tracking regional banks, was up about 8% this year as of Monday. The KBW Nasdaq Bank Index, which tracks larger banks, was up a more meager 3.5% this year. Both lagged the S&P 500 index, which gained 12%.

Investors were shifting away from high-growth tech stocks this summer, driving allocations toward banks and other value sectors, says Stephen Scouten, a bank analyst at Piper Sandler & Co. That rotation slowed by mid-August, however, and may continue to do so thanks to the fresh overhang of higher bond yields, Scouten says.

“It feels like a lot of that has played out,” he says. “I’m not getting incrementally new calls and inquiries from generalists.”

Softer Sentiment
It’s a contrast to two years ago, when bank stocks were still so battered after Silicon Valley Bank’s failure that generalists started returning — and did so more convincingly after Trump’s victory.

“If you were on your toes, you would be looking for what might have to happen for the environment to change, for earnings to start coming up,” says Jeff Davis, managing director at Mercer Capital’s Financial Institutions Group.

Many of those catalysts have already passed, he says. Bank earnings rose the last two years as margins rebounded, but now deposit rates began creeping up again in the second quarter. M&A surged last year, but it’s slowed in recent months. And past dour forecasts for the economy — one model predicted a 100% recession probability by late 2023 — have long since proven too pessimistic.

“As a generalist, you want to front-run that because if you wait until it’s happened, it’s too late,” Davis says. Bank stocks are likely returning to being “grinders,” he says, driving decent returns for investors without staging big rallies.

Positive sentiment on banks appears to be waning, Stephens Inc. analysts led by Matt Breese wrote in a note on their fall survey of bankers and investors. Some 57% of investors expected banks to beat the broader market through year-end, down from the 81% that foresaw banks outperforming at the start of 2026, the survey found.

It also flagged potential triggers for a rebound, such as an acceleration in M&A, stronger loan growth and easing rate pressures for banks — which are paying up for deposits again all while competition forces them to sacrifice on the interest rates they charge.

Strong Economy
There’s a good case for owning bank stocks nonetheless, says Tim Thomas, chief investment officer at Badgley Phelps, a Seattle-based wealth management firm.

“They’re the plumbing of the financial system, so when the economy is doing well, generally banks are going to be doing well,” he says.

There are undoubtedly challenges the economy is facing — the latest being whether inflation and higher interest rates will weaken U.S. growth. But it has withstood a series of shocks over the years and remains “on pretty solid footing,” Thomas says.

Consumers haven’t pulled back on spending, even as consumer confidence slumps to levels last seen a decade ago. Retail and food sales outperformed analyst expectations in August and jumped 6% from last year, which includes the impact of higher prices, according to the Census Bureau.

Job growth appears to be ticking up. And the artificial intelligence buildout is fueling U.S. growth, driving more lending and capital markets deals at banks.

To be sure, banks’ earnings growth will be quite modest compared to the “pretty spectacular growth expectations” at technology companies, Thomas says. But that also means the valuations on banks aren’t as demanding.

“We like the banks as part of a diversified portfolio,” he says. “It’s a way of getting access to not just AI, but cyclical investments without some real demanding valuation.”

A Changing Market
Thomas expresses his positive view on the industry through buying stocks in big and regional banks, preferring those with less earnings volatility, strong balance sheets and with a laser focus on risk management.

It’s a stock-picking approach that’s gotten less prevalent given the rise of index funds and ETFs, which help investors try to diversify away from company-specific risks. “The indexation of markets has been a massive shift over the last five years,” says Piper Sandler’s Scouten.

Rather than buying individual stocks, some generalist investors opt for buying the KRE when they like regional banks or buy a big-bank index when they see Wall Street banks outperforming. Volatility has picked up, with fewer buy-and-hold investors and flows sometimes leaving just as quickly as they came in, Scouten says.

The KRE index does stretch fairly deep into mid-sized banks, with over 150 individual holdings, according to the latest factsheet from State Street Investment Management. But the typical community bank stock won’t get the same boost when generalists turn positive on the sector, Scouten says. “It’s not on their radar,” he says.

Reaching Generalists
It is why public bank executives should be proactive and set up meetings with active fund managers, says Moira Conlon, founder and CEO of Financial Profiles, which advises banks on public and investor relations. “You’d be surprised how many people say ‘yes,’” she says. “We see it every day. It works.”

Some investors are indeed adopting more passive strategies, but other funds have a clear mandate to actively search for small and mid-cap stocks — whether in banking or other sectors. Strong management is key to those investors, who want to ensure a bank is “led by people that have been through cycles, that know what they’re doing,” she says.

“Generalist investors tend to look for great management teams, interesting stories they can get their head around,” she says. “They like stories that they can relate to and understand without getting too far in the weeds.”

Those investors are no doubt well-versed in bank metrics, from net interest margins to loan write-offs. But with so many banks to pick from, bankers need to identify what makes them unique.

“Tell them a story, and then have the supporting financial metrics,” Conlon says.