Excitement over bank stocks since President-elect Donald Trump's election victory looks a little overheated, analyst Dick Bove is telling clients.
Banks have been the sexiest trade since the Republican's upset win. Investors have pushed the KBW Nasdaq Bank Index up more than 23 percent since Election Day.
Fueling the enthusiasm is a belief that the new administration will push a pro-growth agenda while rolling back bank regulations like the Dodd-Frank reforms, and that the Federal Reserve will continue to raise interest rates.
However, Bove believes that while all of that could happen in the long run, the near-term picture for banks is a little less glamorous. Cost-cutting rather than revenue growth will factor more into profits, he said.
"In general, fourth-quarter reports are expected to demonstrate limited revenue growth and strong expense control," Bove, vice president of equity research at Rafferty Capital Markets, said in a note to clients. "Results could be moderately better but not in line with the stock price increases. This creates a potential risk."
As a sector, financials are supposed to have the second-highest returns of the 11 sectors in the for the fourth quarter, according to FactSet. Profits are projected to rise 14.5 percent for the group, compared with the 3.2 percent expected for the index as a whole.
However, Bove said the internals won't be as stellar.
Loan growth for the quarter likely will be at its lowest annualized growth rate in three years, due in large part to a slowdown in the commercial and industrial part of the business. Commercial real estate and home equity lending also slowed, though consumer lending was a bright spot.
Bove does expect trading volumes to reflect a 15 to 20 percent rise.
But where banks have really excelled in the low-growth environment has been in keeping expenses low. Costs have grown on average just 1.2 percent per year since 2009 and have been effectively flat over the past two years, he said.
"The net result is that the fourth-quarter figures for the industry are expected to be flat to down," Bove said. "This will be the source of the earnings increase expected in this period. Expense control will also be a significant factor in 2017's earnings performance."
To be sure, Bove's skepticism is not universally shared. Some analysts believe 2017 could be another big year as banks amp up risk activity. Others see room for the rally to run but believe investors should be selective on individual bank stocks.
Bove also believes bank stocks "are likely to move higher." However, he cautioned clients to check their enthusiasm over the immediate impact of lower regulation and higher rates.
"The expectation is that 2017 results will be more positive growth, but this is highly dependent on the ability of the industry to grow its loan portfolio and control costs. It will not be due to changes in interest rates," he said. "If investors do not realize this, these stocks will be at risk."