Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Bove: Don't fear the Fed for bank stocks

How the Fed rate hike affects the stock market
How the Fed rate hike affects the stock market

Banks are likely to be the bellwether of how financial markets accept rising interest rates, so it's not surprising to see the sector take a hit as of late.

Investors bailed on the group last week as the market anticipated a Federal Reserve rate hike Thursday, only to see the U.S. central bank again back off a move. Banks were the worst-performing sector for the week, collectively losing about 2.5 percent.

Analyst Dick Bove thinks the selloff was a mistake.

"Right now the values in bank stocks are incredibly high," the vice president of equity research at Rafferty Capital Markets told clients in a note Monday. "Major commitment of funds to the sector makes sense."

Dick Bove
Jin Lee | Bloomberg | Getty Images

It's been a tough year for the group, which has underperformed the broader market. The KBW Nasdaq Bank index is down about 5 percent for the year, worse than the S&P 500's drop of 3.8 percent as of Monday morning. The index was rallying Monday on the heels of a broader market move higher.

Last week's Fed decision to keep its key funds rate near zero came largely over concerns about global growth. That in turn may have spooked bank-stock investors who fear that a global recession would be felt worst in the financial sector.

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Bove said that even in the case of a global slowdown, a low-rate environment will keep a floor under bank stocks.

"One immediate impact of the failure to raise interest rates is that it caused the value of bank assets to rise and it improved real book values," he wrote. "This is because an estimated 92 percent of bank assets are financial instruments. If interest rates remain stable or decline slightly, the value of these assets rises in real terms. This improves banking industry book value."

Higher rates also can boost banks by increasing margins, though that applies to rates rising in a stronger economy, which presumably would be the case.

Bove urged a focus on bank earnings, which he said are solid.

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The broad financial sector is expected to grow 7.8 percent in the third quarter, 8.9 percent for 2015, then 11.3 percent for all of 2016, according to S&P Capital IQ.

"No one is estimating that banks will lose money this year or next or the year after that," Bove said. "Book values will rise creating more economic value in bank stocks."