Bank Stress Test and the Big-Bank S&P500

The Fed is completing its annual stress test in the wake of the collapse of regional banks earlier this year, but will it find anything to worry about?

Big (and Small) Banks on the Docket Again

The Federal Reserve will announce this year's banking stress test results on Wednesday. Regional banks are likely to be in focus after the chaos back in March, which saw several banks go under due to rising unrealised losses. Among the beneficiaries of the banking "mini-crisis" were major banks which saw a rush of inflows for safety. While some of those flows have balanced out in the subsequent months, depositors still prefer big banks. And if there are some negative results from the stress test, they could see some further gains.

The stress test measures banks' capacity to weather a severe economic downturn by examining their balance sheets. As a result of the test, banks must maintain a certain amount of capital to be considered healthy. Excess capital can then be returned to shareholders through dividends and buybacks. But if there is insufficient capital, it could trigger concerns from depositors and shake up the banking industry again. Big banks have been accumulating reserves over the past year in anticipation of a recession, which could put them in a much better position regarding the stress tests. But, also, the tests could indicate how much capital banks will continue to hold in their balance sheet once the recessionary decompression is over and signal how much profitability they might report in a "soft landing" scenario.

Losses Haven't Been Regained

The big issue around the stress tests is likely to be, once again, the "unrealised losses" due to high interest rates. Since March, the yields on benchmark US Treasuries have remained relatively stable, despite the Fed continuing to hike. The government's lack of new debt issuance amid the debt ceiling debate helped keep yields down. But, the unrealised losses will have to be factored in by the stress test, which could mean many regional banks will have to increase their reserves. They might have to cut dividends and lower their stock prices to do that.

If banks pass the test with flying colours despite the current conditions, it could boost the stock market, even if the major banks don't see as much of a gain. The good news about the banking system, in general, could help support equities more generally and benefit the S&P 500. If the stress test isn't as good, a more concerning outlook for banks might see investors again shifting from regional banks towards larger banks, which would likely support the financial sector in the S&P 500, but generalised worries could drag on other sectors in the index.

S&P500 at Risk With Possible Wedge Under Formation

The big bank S&P500 index appears to correct into the lower 4300s, with a breakdown of said support exposing 4150. Depending on the bearish price action structure, the index could bounce for a correction by 4300 or a full-blown reversal; or by one of the lower supports.

At current, the downward formation resembles a wedge pattern, which is typically corrected deeply. This suggests that any upside could see the index reaching near 4400 before reversing, or at least before further clarity is provided. A further continuation, for example, could provoke bets towards 4450 and 4500 next.

Source: SpreadX / SPX 500

Key Takeaways

The Federal Reserve will announce this year's banking stress test results on Wednesday. The test measures banks' capacity to weather severe economic downturns, and banks must maintain a certain amount of capital to be considered healthy. If there is insufficient capital, it could trigger concerns from depositors and shake up the banking industry again. Banks that pass the tests with flying colours could boost the stock market, even if the major banks don't see much gain, but if the stress test isn't as good, it might cause generalised worries, which could drag on other sectors in the index.