- While the broader market seized up, bank stocks broke out.
- As rates move higher, bank revenue and share prices could also rise.
- Motifs mentioned: Too Big to Fail
- Stocks mentioned: Goldman Sachs (NYSE:GS), Bank of America’s (NYSE:BAC), JPMorgan (NYSE:JPM).
The tumult leading into the presidential election hasn’t been especially great for investors. The S&P 500 has lost more than 2 percent over the past three months as anxiety about the country’s political future has appeared to rise each subsequent week.
For those investing in bank stocks, however, peace of mind has been a little easier to come by.
The Nasdaq Bank Index rose nearly 6 percent in October, a month that was beneficial for most bank-related investing vehicles. The Too Big to Fail motif has increased 3.6 percent in the past month. In that same time, the S&P 500 has fallen 1 percent.
In the past 12 months, the motif has decreased 0.6 percent; the S&P 500 is up 1.5 percent.
The recent earnings season has certainly helped. Shares of Goldman Sachs (NYSE:GS), which comprise about a 6 percent weighting in the motif, gained more than 10 percent in October after the company blew away Wall Street’s third-quarter profit and revenue expectations. The investment bank said it benefited in particular from improved trading revenue. Net revenue from its fixed income, currency, and commodity unit soared 34% from a year earlier.1
A hotter merger market also contributed. Goldman pointed out that it is tops worldwide in completed deals this year, which boosted its advisory income. In addition, the company saw $14 billion in net inflow in long-term assets under supervision.
Just as earnings season headlines have started to wane, however, the sentiment toward virtually all stocks was revived earlier this week from what most analysts were suggesting was optimism toward the likely election of Hilary Clinton.
Adding to the future bullish case for banks has been an apparent rebound in both growth and inflation in the US economy, which could lead to higher interest rates, a boon for the financial sector. As the Wall Street Journal pointed out last week, the government’s recent report on jobs and wage data reinforced a positive economic picture, while expected post-election fiscal stimulus would also support rates by expanding the supply of government bonds.2
The 10-year U.S. Treasury now yields around 1.8%, which marks a slow but steady climb since early July. Higher rates should help commercial banks earn more on loans. According to the Journal, Bank of America’s (NYSE:BAC) balance sheet is most geared to benefit from rising rates among big US banks, thanks to a large, low-cost deposit base and big holdings of mortgage-backed securities.
Bank of America recently announced that its pretax interest income would rise by some $5.3 billion, equivalent to around 20% of this year’s total expected pretax earnings, if short and long-term rates were to both go up by 1 percentage point at the same time. JPMorgan (NYSE:JPM) said its earnings would rise by $2.8 billion, or 8 percent of this year’s expected pretax earnings, the Journal reported.
A rising rate environment also would generate trading revenue for the large investment banks, since clients would be prompted to reposition portfolios for an environment where rates could rise significantly.
Despite the recent outperformance by banks, the Journal noted that the sector may still be undervalued. Before Monday’s big market jump, the S&P 500 financial sub-index was trading at about 12 times forward earnings, compared with 16.2 times the overall index. As Janus Capital analyst Barrington Pitt Miller told the Journal, economically sensitive industries like banks could certainly benefit from more fund inflows as rising growth pushes investors out of defensive sectors.
That suggests that investors who missed the current rally in bank stocks have an opportunity to take part in another one.
1John Maxfield, “The Best-Performing Big Bank Stock in October”, foxbusiness.com, Oct. 31, 2016, (accessed Nov. 7, 2016).
2Aaron Back, “Bank Stocks Still Have Lots of Room to Run,” wsj.com, Nov. 4, 2016.