In a move that has caught the attention of investors, Morgan Stanley analysts on Monday adjusted their outlook on large- and mid-cap banks, citing growing concerns over the potential for a recession spurred by President Donald Trump’s tariffs. In their latest assessment, the firm downgraded the banking sector, shifting its view from “attractive” to “in-line,” and signaling that the ongoing trade tensions could significantly dampen future economic growth.
The Impact of Tariffs on Bank Performance
Morgan Stanley’s revised stance on the banking sector highlights the increasing risks posed by tariffs and trade policies to broader economic conditions. According to analysts led by Betsy Graseck, the U.S. economy is showing signs of strain, with recession risks now more pronounced. While the firm still expects a slowdown in gross domestic product (GDP) growth, the new concern is the escalating uncertainty surrounding the impact of tariffs. This uncertainty is expected to delay any recovery in capital markets, slow loan growth, and lead to an uptick in loan charge-offs across both consumer and commercial loans.
One of the key factors weighing on the economy is the ability of American consumers to absorb the added costs from tariffs. The Morgan Stanley analysts pointed out that while U.S. consumer spending has been a crucial driver of economic expansion, many households do not have the savings cushion needed to sustain spending levels in the face of rising prices due to tariffs. This reduced consumer spending could result in weaker-than-expected growth across various sectors, including banking.
Goldman Sachs Takes a Hit, While Bank of America Benefits
In addition to their broader sector downgrade, Morgan Stanley also made specific adjustments to individual bank stocks. Goldman Sachs, long a favorite among investors, was downgraded from “overweight” to “equal-weight,” reflecting the firm’s higher exposure to investment banking revenues. According to Morgan Stanley, investment banking is particularly vulnerable to recession risks and deteriorating market conditions, making Goldman Sachs more susceptible to the economic slowdown than traditional commercial banks. The bank’s stock saw a modest decline of nearly 1% following the downgrade.
In contrast, Bank of America was upgraded to “overweight” from “equal-weight,” as analysts highlighted the bank’s attractive valuation in light of current market conditions. Bank of America’s diverse business model, which includes both investment banking and consumer banking, positions it more favorably compared to its peers in a slowing economy. Following the upgrade, Bank of America’s shares surged by 2.7%, showing that investors are placing their bets on banks with solid fundamentals and lower exposure to recession-sensitive areas like investment banking.
Recession Fears Mount for Mid-Cap Banks
The downgrade wasn’t limited to just the largest players in the sector. Morgan Stanley also took a cautious stance on mid-cap banks, with analysts led by Manan Gosalia citing the increasing risks posed by tariffs. The firm’s revised outlook for mid-cap banks reflects concerns that tariffs will weigh heavily on loan growth, leading to downward pressure on earnings per share (EPS) and future valuations. With tariffs potentially driving up costs and slowing consumer and business spending, mid-cap banks could face significant challenges in the near term.
As the economic landscape becomes more uncertain, investors are likely to be more cautious about banks that are more exposed to tariff-related risks. These institutions may struggle to maintain strong earnings growth and profitability if economic conditions continue to deteriorate.
The Broader Economic Implications
The latest developments in the banking sector reflect broader concerns about the U.S. economy. The combination of trade uncertainties, rising tariffs, and slower-than-expected GDP growth is beginning to take a toll on both consumers and businesses. For banks, the challenges are twofold: not only are they facing the risk of a slowdown in loan demand, but they also have to contend with the possibility of increased defaults as consumers and businesses struggle to adjust to higher costs.
Additionally, the uncertainty surrounding the trade war is leading to volatility in the financial markets, which can further dampen investment banking activity. As seen with Goldman Sachs, banks that rely heavily on capital markets for revenue may find their earnings under pressure if market conditions deteriorate.
A Shift Toward Caution
In response to these risks, Morgan Stanley’s latest actions signal a shift toward a more cautious approach when it comes to bank stocks. While large-cap banks like Goldman Sachs are expected to face more challenges due to their exposure to investment banking, mid-cap banks are also likely to encounter headwinds as tariff-induced risks continue to escalate.
The focus now turns to how other analysts and investors will respond to the growing uncertainty in the banking sector. With recession fears on the rise and tariff-related risks increasing, it’s likely that more firms will follow suit and adjust their outlooks on banks, particularly those with significant exposure to trade-sensitive industries.
For investors, the key takeaway from Morgan Stanley’s updated assessment is the growing need for caution in the banking sector. While certain banks, like Bank of America, may benefit from diversified revenue streams and attractive valuations, others—especially those heavily reliant on investment banking—may struggle to weather the storm. As the global economic environment continues to shift, banking stocks are likely to remain under pressure, and investors may want to reassess their positions as new data on tariffs and recession risks emerge.
In conclusion, the combination of increasing tariff risks and the looming threat of a recession has forced analysts to reconsider their outlooks on the banking sector. Morgan Stanley’s downgrades reflect these concerns and highlight the challenges facing large and mid-cap banks in a more uncertain economic climate. As trade tensions persist and the economic outlook becomes more clouded, banks will need to navigate these turbulent waters carefully to maintain growth and profitability.
