It’s not hard to make a case to bet against US bank stocks. The industry’s total profits are down 70% in the first quarter of the year and a wave of potential bankruptcies are putting their recovery at further risk. A group of high profile investors are optimistic about the future of the banks and believe banks are still the best way to take advantage of an economic recovery.

Banks, so primitive

The S&P 500 Financial index, an index representing the largest US bank stocks, is down over 17% in 2020. The broader market index, S&P 500, is up over 8% in 2020. Here’s why they’re struggling:

Falling interest rates… Big banks earn nearly half of their revenue from interest on consumer and business loans. Falling interest rates reduce the amount that banks earn on these loans.

• Due to COVID, US interest rates were lowered from 1.75% to 0.25% which made it cheaper for businesses and individuals to take out loans in hopes of encouraging economic activity.

Risk of bankruptcies…In 2020, over 424 companies have filed for bankruptcy with nearly half these companies in the retail and oil & gas sectors. If a company files for bankruptcy, loans made to them may not be paid back which triggers a loss for the banks who made these loans.

• Bank of AmericaBAC
  and Wells FargoWFC
  are the most exposed to retail bankruptcies.
• CitigroupC
  , Wells Fargo and Goldman SachsGS
  are the most exposed to oil & gas bankruptcies.

In times of crisis, the wise invest while the foolish run

Patrick Kaser, managing director of Brandywine Global Investment Management, is favoring large banks like Bank of America, Citigroup and JPMorgan Chase. These banks are protected by their investment banking divisions which showed higher profits during COVID. These investors are anticipating big gains when a vaccine is developed and the economy recovers.

• Soros Fund Management, a well known investment fund, has added over $88m worth of Bank of America, Citigroup and Morgan Stanley stock to their portfolio in the second quarter of 2020.

Should I be worried about bankruptcies?

To prepare us for disappointment, the largest 15 US banks set aside $76b to cover loans that may not get paid back. As long as they meet these expectations, their stock prices won’t change much. However, if banks report a higher than expected number of bankruptcies, stock prices could fall. If we see better results, their stock will rise.