The bank rally may have more room to run

Traders on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

The bank rally continues. It may have been a lackluster trading day, but once again banks rallied to new highs, including money center banks like Morgan Stanley (MS), Citigroup (C), JPMorgan (JPM) and Goldman Sachs (GS), as well as large regional banks like SunTrust (STI), Huntington Bancshares (HBAN), KeyCorp (KEY), Comerica (CMA), Wells Fargo (WFC) and Fifth Third (FITB).

Large-cap banks have significantly outperformed the S&P 500 this quarter.

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TT banks 150623 EC

Change
Large cap banksUp 10.7%
S&P 500Down 2.6%

It helps that as rates have moved up; there has been rotation out of interest-rate-sensitive sectors, which has freed up money that is being put into banks.

Interest-rate-sensitive quarter-to-date:

Trader Talk Ward 150623 EC

Change
REITsdown 8.0%
Dow Utilities down 4.4%
Home builders down0.02

This is an ongoing story: money has been moving into banks for more than a month. As these stocks started breaking out a month ago, volume in key ETFs like the SPDR S&P Bank ETF (KBE) and the SPDR S&P Regional Bank ETF (KRE) both saw a surge in volume.

What's moving the banks? Improved economic data has been a big help, so there's been hope that loan growth would improve. That's been happening, but it hasn't translated into revenue growth because rates are so low.

But the most important factor has been the belief that short-term interest rates would be moving up. Most bank loans are tied to short-term rates.

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Should you chase this rally? It concerns me that bank stocks are up 11 percent this quarter, but there may be more upside left.

If the Fed funds rate goes to 0.6 percent by the end of this year, and 1.7 percent by the end of next year, which is pretty much what the Fed is projecting, you could get a 20 to 30 percent increase in the bottom line of many banks, says Robert Albertson at Sandler O'Neill.

That would imply that there is still more upside.