Here's Why Bank Stocks Had a Stellar 2017

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Bank stocks have consistently performed well since bottoming out in the wake of the financial crisis. But this past year was nevertheless one to remember for people who hold bank stocks in their portfolios.

If you go back to before the presidential election last year, the KBW Bank Index, which tracks shares of two dozen large-cap bank stocks, has handily outperformed the broader market. All told, the KBW Bank Index has surged 42% since the week before the election. The S&P 500, meanwhile, is up 26% over the same stretch.

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Two catalysts fueled bank stocks

With the benefit of hindsight, it's clear that there were two catalysts for the growth in bank stocks. The first was then-presidential candidate Donald Trump's vows on the campaign trail to dismantle the Dodd-Frank Act, which was passed in 2010 to address the causes of the banking crisis two years earlier.

If regulations in the bank industry are relaxed, compliance costs at banks would drop, which would bolster their bottom lines. An easing of regulations would also, there is reason to believe, encourage more innovation in the financial industry, as there would be less fear of regulatory blowback for mistakes and errors uncovered in the early stages of a new product or service.

The flip side of this, of course, is that an easing of regulations could chip away at important safeguards put into place by the Dodd-Frank Act that add to the safety and soundness of the bank industry. This includes things like the Volcker Rule, which prohibits banks from proprietary trading -- acting, in a sense, like a hedge fund.

Moreover, the recent moves at the Consumer Financial Protection Bureau, most importantly the appointment of a new leader at the agency, could encourage less scrupulous companies on the periphery of finance -- payday lenders, for instance -- to employ unsavory practices to boost revenue and earnings at the expense of consumers.

Tax reform

The second catalyst that fueled the growth in bank stocks this year is the hope for a corporate tax cut. President Trump campaigned on the promise to cut the corporate tax rate to 15%, down from 35%. As the legislation has taken shape, however, it looks increasingly likely that the rate will be closer to 20%.

This would be especially beneficial to banks, which explains why the KBW Bank Index has rallied so much in the past 13 months. The reason banks would benefit so much is because they pay a lot in taxes. In fact, three out of the top five S&P 500 companies that pay the most in taxes are all banks: JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), and Wells Fargo (NYSE: WFC).

This goes a long way toward explaining why shares of Bank of America and JPMorgan Chase, in particular, have seen their stocks perform so well since the beginning of November 2016. Bank of America is up 74% over this stretch. JPMorgan Chase has climbed 53%.

Wells Fargo, by contrast, is a bit of an exception. The California-based bank has struggled to put a multiyear fake-account scandal behind it. The news was first widely reported in September 2016, when the CFPB announced that it was fining Wells Fargo for opening accounts for customers without their approval to do so. Since then, there's been a regular drip of news about similar practices in other areas of Wells Fargo's operations. The net result is that the nation's third-biggest bank by assets has seen its shares lag its peer group, up 30% since before the presidential election.

It still remains to be seen whether the tax bill will actually be able to get the votes it needs to pass. Republicans are in the process of reconciling the House and Senate bills into a joint final version, which will then be voted on again. With Republican Sen. Bob Corker already signaling that he won't support the bill, that narrows the margin for error down to only two votes, given the current split in the Senate.

The market is reflecting confidence that the tax bill will pass, as stocks have rallied throughout the year. But there are still a handful of hurdles ahead, including the recent news that Sen. Marco Rubio (R-Fla.) has said that he will vote against the bill unless it expands the child tax credit. Sen. Mike Lee (R-Utah) has taken a similar position, which explains why he remains undecided on whether to vote in favor of the final version of the bill.

Ultimately, the outcome of the tax bill seems like it's the largest catalyst on the horizon right now. Stocks may not surge if it passes, as much of the gain already seems to be incorporated into stock prices given the performance of the market over the past 13 months, but they could go in the other direction if the bill fails.

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John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.