On Friday, the yield curve inverted.
For many experts on Wall Street, a yield curve inversion is one of the strongest warning signs of a coming recession.
After all, a recession has followed the last seven times it has happened.
This extremely reliable predictor reared its ugly head Friday when the 10-year Treasury note yielded less than the three-month Treasury bill for the first time in more than a decade.
The good news: We have plenty of warning.
On average, a recession follows a yield curve inversion by about a year.
That means investors have time to prepare their portfolios for the upcoming storm. More importantly, policy makers in the government and at the Federal Reserve have time to change to an aggressive pro-growth stance.
It's that policy change that creates opportunity, specifically in regards to the banking sector.
Over the last two weeks, several economic data points suggested significant global weakness that has the potential to drag on U.S. business activity.
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The market did not take kindly to the new data.
In particular, bank stocks have sold off hard in the month of March. The SPDR S&P Bank ETF (NYSE: KBE) has lost more than 10% of its value since the middle of the month.
The selling makes sense in an inverted yield curve environment.
Banks make money by borrowing at a low cost and lending at higher rates.
That almost always happens in a normally upward sloping yield curve environment, but not when the yield curve is inverted.
Longer-term, these sorts of dislocations are usually corrected. So the selling in bank stocks in March provides an excellent opportunity to buy.
That's part of the reasons so many bank stocks rank so highly now on the Money Morning Stock VQScore™ system.
Here are my top three regional bank stocks to buy now that the yield curve has inverted...
Best Bank Stocks to Buy, No. 3
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The VQScore loves beaten-down stocks, and the yield curve inversion has beaten down plenty of banks, like Capstar Financial Holdings Inc. (NASDAQ: CSTR).
Capstar is a regional bank operating in the southeast.
Interestingly, the company was founded in 2007, at the peak of the housing crisis. Its ability to navigate the financial collapse and emerge as a publicly traded company in 2016 is impressive.
Shares of Capstar are down 15% since the beginning of March, but let's not stop there.
The yield curve collapse actually began a year ago, when the U.S. Federal Reserve took a strong hawkish stance on interest rates.
The bond market wasn't buying the policy, and long bond yields fell precipitously.
For Capstar, that was bad news, and investors reacted by cutting the valuation by 30% since late May 2018.
Analysts expect Capstar to grow profits by 10% this year despite the yield curve inversion.
The time to buy is not when the recession hits.
By then, the focus will be on recovery.
That means the time to buy is now.
Given Capstar's relatively small size with a market cap of $250 million, I wouldn't be surprised if the bank was acquired by a larger player in the very near future.
Trading for just 12 times last year's earnings makes Capstar one of the best regional bank stocks to buy now that the yield curve has inverted.
Best Bank Stocks to Buy Now, No. 2
If you are looking for a larger regional bank to buy now that the yield curve has inverted, consider Zion Bancorp. (NASDAQ: ZION).
Shares of this $8 billion market cap regional bank have dropped 12% in March and 20% since May 2018.
That selling may have been justified given the aggressive stance of the Federal Reserve, but how much further will valuations be cut?
It's impossible to know exactly, but it's pretty safe to say that the Fed has done an about face in policy when it has been needed.
If that is the case, the yield curve will steepen quickly, and bank stocks will soar.
Analysts expect Zion to grow profits by 9% in 2018.
With shares trading for only 11 times last year's earnings, the stock is a screaming buy according to the VQScore system.
The time to buy is now, before the rest of the market realizes the opportunity here.
Best Bank Stocks to Buy Now, No. 1
In between Zion and Capstar market cap--wise is Westamerica Bancorp. (NASDAQ: WABC).
This $1 billion regional bank operates in northern and central California.
Shares of Westamerica have fallen by only 5% in March, making it one of the best-performing banks this month.
In fact, since May 2018, Westamerica has actually gained value.
Clearly, the company is doing something right, as the stock is performing well in challenging conditions now that the yield curve has inverted.
We can find the answer in the market Westamerica operates.
The northern California economy is red-hot, thanks in large part to Silicon Valley.
A large number of privately held technology companies like Uber plan to go public this year, creating hundreds if not thousands of instant millionaires.
Those millionaires will feel emboldened to go out and buy real estate.
All of that activity will boost earnings at Westamerica, inverted yield curve or not.
Analysts expect Westamerica to grow profits this year by a very healthy 11%.
Investors wanting to own the company today will have to pay a premium valuation of 23 times last year's earnings.
Normally, I would be averse to paying such a premium, but with the Federal Reserve on our side, I'm willing to take the risk.
The reward is certainly there, especially if the inversion of the yield curve misses the mark in terms of predicting recession.
Westamerica is a great growth economy regional bank to own now.
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