Bargain hunters are flocking to US bank shares, despite concerns they’ll continue to struggle. In 2023, the S&P 500 bank index plummeted approximately 11%, following the failure of several lenders, marking the worst banking crisis since 2008. In contrast, the broader S&P 500 rose by around 15%. According to BofA Global Research data, bank stocks are historically low compared to the S&P 500, but their low valuations are drawing in some investors, trading at eight times forward earnings compared to the S&P 500’s 19.7 valuation.

While some investors are cautiously optimistic, others are skeptical, unsure whether the appealing valuations are a trap. This uncertainty stems from the effects of the Federal Reserve’s monetary tightening, which has led to the highest US interest rates in decades. Higher rates offer a benefit to lenders, but they also increase the attraction of yield-generating investments and decrease demand for mortgages and consumer lending.

Although most investors believe there won’t be further rate increases, the possibility of the Fed maintaining current levels through most of next year has dampened excitement for bank stocks. However, some contrarian investors are taking the leap, as evidenced by the Financial Select Sector SPDR Fund’s net inflows of $694.59 million, marking its best weekly showing in over three months. BofA Global Research suggested that investors “selectively” add exposure to bank stocks in anticipation of an interest rate peak, recognizing that the sector’s risks include higher rates pressuring margins and issues with commercial real estate.

Market veteran Bill Gross stated that the bank sector had hit bottom and disclosed holding several regional bank stocks, sparking strong rallies in their shares. Other market participants, like Neville Javeri, a portfolio manager at Allspring Global Investments, are bullish on the potential hidden value in banks, as larger banks have considerably cut costs and are positioned to raise dividends and increase buybacks, mitigating the impact of slowing loan growth. Stocks recommended by BofA’s analysts are shares of Goldman Sachs and Fifth Third Bancorp.

Despite some optimism, many investors and analysts remain pessimistic on bank stocks. Historically high mortgage rates have hindered lending, as evidenced by about 61% of all outstanding mortgages having an interest rate below 4 percent, reducing the incentive for consumers to refinance or seek new loans.

As the Fed asserts its commitment to maintaining higher rates, analysts have been lowering growth estimates for financials, including banks and insurance companies. The sector is expected to post earnings growth of 6.2% in 2024, down from prior estimates of 11.4%. Jeff Muhlenkamp, lead portfolio manager at Muhlenkamp & Company, emphasized the lack of certainty that the worst is over for bank stocks. These uncertain conditions have made the future performance of bank stocks uncertain. This will be further clarified by U.S. consumer price data due next week.