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After years of trading at the steepest discount in the broader market — dead last among all major sectors — the banking industry is finally positioned to narrow that gap, according to KBW CEO Tom Michaud.
Michaud said in the latest Street Talk podcast that the best fundamental environment in years, historic levels of excess capital, a once-in-a-generation change in the regulatory environment and rebounding M&A activity should support stronger valuations for regional banks in 2026.
Larger bank stocks have lagged the broader markets in recent years, but the underperformance has been far greater among regional bank stocks. Over the last three years, the S&P 500 index has increased by 67%. The BKX index, which comprises the 25 largest banks, has risen almost 49% during that time frame. The KRX, meanwhile, which includes the next 50 largest banks, has risen just 15.6% during the same period.
Michaud believes that dynamic is set to change and expects regional bank stocks to recapture some of the valuation discount to bigger banks and the overall broader market. The executive noted that regional banks' discount to larger banks is the largest it has been in five years. However, he expects strong fundamental performance for regional banks in 2026 and believes the results will narrow that gap.
"The green lights for this sector right now are very good. Strong balance sheets, good and improving profitability profile, changing regulation in their favor and the economy is good. It's green lights on this trip right now," Michaud said.
Michaud said financials generally contribute 17% to 18% of the broader market's earnings, yet they only account for 12% to 13% of the overall market cap. He said financials have historically traded at a discount to the broader market because investors believe the rest of the market tends to grow faster, but the current gap between contribution to earnings and contribution of market cap is the largest of any industry vertical.
"When you look at the financial gap between contribution of earnings to overall market cap, financials have the biggest discount of the 10 or 12 major economic verticals in the market. Dead last. So my view is we don't have to trade at a market multiple," Michaud said. "But dead last for the fundamental outlook of the banking sector seems like a little too severe to me."
In addition to a positive earnings outlook, Michaud said the banking industry currently boasts significant levels of excess capital and should grow capital levels even further. That puts institutions in a position to grow organically, buy back stock and raise dividends.
Banks are also using their capital to grow through acquisitions. A friendlier regulatory has encouraged more deal activity by speeding up the closing time of transactions, while bringing larger banks back into the acquisition arena. However, Michaud said that the next presidential election could change the regulatory framework and result in a policy that prohibits larger banks from being buyers. The potential for such a change could influence some would-be sellers to consider partnering with another institution in the near term while the deal window remains open.
"If you think that you are a seller in the next couple of years, you should probably do it while the biggest banks are in the market rather than running the risk of doing it when the bigger banks aren't in the market," Michaud said.
The regulatory environment is one of several catalysts encouraging more deals, which also includes the push for scale, healthier valuations in the sector and shareholder activism. Still, Michaud noted that consolidation is really driven by management teams' desire to build better and more profitable banks. He said that institutions are trying to build scale to allow them to invest in technology to more effectively compete with nonbank competitors.
"Scale allows you to make the investments that you need to survive. And if you don't have the scale to make these investments, you run the risk that stablecoin or some other development will be so powerful, it will jeopardize your core model," Michaud said.
