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Growing up in Philly, I developed an appreciation for the "little guy." My father, uncle and grandmother were all small business owners, and some of my fondest memories were the times I spent working with them and the people I met along the way.
I vividly remember our neighborhoods lined with small row homes, many with businesses on the bottom floor where you could get anything from a good cheesesteak to a loan from one of the many regional banks.
Back in the day, small businesses were the soul of the city (and America), and banks often supplied the capital to keep them going. At the time, the business landscape wasn't dominated by gigantic banks, big-box stores or mega chains. It was a menagerie of boutique business owners from every background, all with the same vision: to make their version of the American dream come true.
Small business is still at the core of our economy and accounts for 54% of all sales in the United States. But one key component of small business commerce in America is dying.
If you're over 40, you might remember a time when small banks dominated the finance landscape. Those days are long gone. Many startup businesses and those looking to grow are now funded by loans and credit from banks and credit card companies.
The number of banks has declined dramatically since the late 1980s, while bank failures have accelerated.
According to the FDIC, an astronomical 518 banks have failed since January 2008, compared to 27 failures between 2000 and 2008. Unfortunately, many of these have been small, regional banks.
CNN reported that only three new banks opened between 2010 and 2015. Prior to the financial crisis and Dodd-Frank legislation, more than 100 banks were setting up shop each year.
Mega banks like JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) have done to regional banks what Wal-Mart (NYSE: WMT) and Amazon (NASDAQ: AMZN) have done to many small retailers.
Small banks lack the resources to fight back. Recent legislation stifles profits and requires adherence to all sorts of new rules and regulations that make it very costly to conduct business. While it's true that smaller banks may not be as restricted as larger companies, the new laws have taken small banks' slim profit margins and sliced them even thinner.
Low interest rates also cut deeply into bank profit margins and discourage depositors from parking their money and using bank products like CDs and money markets.
It's a poor banking environment for everyone, but large, established banks have an advantage because of their sheer size, technology and market control.
Another Major Hurdle in an Already Tough Environment
The unfair environment for regional banks should be enough of a reason to steer clear of most small banks, but two more bearish catalysts are going to put serious pressure on regionals (and banks in general) in the coming months. A decline in business spending and a slowing economy could be the coup de grâce for a great number of struggling regional banks.
The Bureau of Economic Analysis (BEA) recently reported that GDP grew a paltry 1.2% in the second quarter and that non-residential fixed investment (which reflects business spending) fell 2.2%. The BEA also reported that the consumer savings rate had dropped 10% from Q1.
It doesn't take a rocket scientist to figure out that if small businesses aren't spending, they probably aren't going to borrow. And if consumers aren't saving, bank deposits aren't going to grow.
These two facts, coupled with a GDP that's barely positive, could be killers for the regional banks.
What This Means for Small Banks and How to Profit
Banks are already on the ropes and praying for a rise in interest rates and an improvement in the economy. Unfortunately, it's likely going to be a lose-lose for the entire group. Banks have already set a cautious tone for the year, and many experts believe the anemic earnings trends will continue into the end of the year.
If the economy continues to sputter, the Federal Reserve will likely keep interest rates low for longer, stifling the banking sector in general but with regionals bearing most of the pain.
If the economy remains stable and the Fed surprises the market with a rate hike, we will probably see a sell-off in the stock market, also driving bank stocks lower.
Let's not forget that the current economic expansion is more than seven years old and one of the longest we've seen since World War II. Statistics point to a coming contraction or stagnation at best.
In just about every realistic scenario, I don't see small banks in a favorable light.
And while that's bad news for the economy and investors, it can be good news for a few savvy investors who decide to profit from the situation.
Make no mistake -- I take no pleasure in describing the facts of the situation. But it's my job as Chief Strategist of the premium newsletter, Profit Amplifier, to show readers how to profit from bullish and bearish market conditions with the power of my simple options strategy.
In Profit Amplifier, I recently recommended selling puts against the SPDR KBW Regional Banking ETF (NYSE: KRE). This is a highly liquid ETF that tracks more than 100 regional U.S. banks. It gives us exposure to medium and small banks and omits the big financial centers like JPMorgan and Wells Fargo.
Even if you don't follow the options strategy we use in Profit Amplifier, the takeaway is clear: Stay away from the regional bank stocks.
Unfortunately, I can't share the exact details of our trade out of fairness to my paid subscribers. But if I'm right, they could make nearly 40% in roughly a month from a small drop in the ETF.
If you'd like to learn more about options and get your hands on our trades each week, then simply go here.
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