It's that time of year again when Wall Street is typically full of cheer, but the mood is far from triumphant this year. Instead, there are increasing concerns that a recession may be on the horizon in the first half of next year. These concerns have been fueled partly by recent economic indicators, such as last week's softer-than-expected reading on the Consumer Price Index (CPI). Initially, this reading boosted stock indices as they rose above their respective 200-day moving averages. Investors hoped that a tame inflation rate compared to the steeply rising CPI earlier in the year could allow the Federal Reserve to ease off the brake pedal. However, these hopes were quickly dashed when the Fed maintained its hawkish tone at a press conference on Wednesday, despite reducing the pace of rate hikes from 0.75 percentage points to just a 50 basis point increase. As a result, stocks have fallen about 6.5% from their opening price last Tuesday.
One sector that had been performing well earlier in the year was regional banks, as represented by the SPDR S&P Regional Banking ETF (KRE). Higher interest rates and a stronger dollar helped boost profits for small and mid-sized US banks, and KREoutperformed the SPDR S&P 500 (SPY) by about ten percentage points through early March. These relative gains continued through the summer and even into the fourth quarter. It was believed that higher interest rates would be a boon for domestic depository institutions and that strong lending rates would further bolster profits.
However, the tide has turned for KRE in recent months. The ETF has fallen significantly from its mid-August high, breaking below its September and October lows. It is now testing its 52-week lows from June, marking a bearish turn after strong outperformance leading up to October 13th, when the market reversed following the September CPI report. This may have also been the short-term peak for this relative value trade.
The breakdown in regional banks is a concerning development, as the industry is often seen as an economic bellwether and has been leading the market for much of the year. This combination makes KRE a key ETF to watch heading into the end of the year. Additionally, according to Equity Clock, KRE typically sees an increase in performance at this time of year on both an absolute and relative basis. However, this trend has yet to materialize this year, adding to concerns about the state of the economy.
Investors would be wise to closely monitor the performance of KRE and other stocks for clues on the economy's direction. With the risks of a recession mounting for the first half of next year, it's essential to be aware of any potential market warning signs. While economic indicators may need to catch up to the actual state of the economy, certain stocks may provide insight into the current state of affairs before lagging indicators do.
