hapabapa
The outlook for the broad market is precarious in 2023 due to rate hikes, slowing consumer spending, and popping asset bubbles. But for well-run bank stocks, these aren’t particularly worrying. For one, big banks like Bank of America (BAC) and JPMorgan (JPM) pay 0.01% on checking and savings accounts and can earn 5% simply by investing deposits in Treasury bills. Second, if consumers spend less and save more, then bank deposits may actually rise. Third, while there are many asset bubbles unwinding in the economy, bank stocks are not one of them, as most bank stocks are trading around 10x earnings. Fourth, unlike the 2008 financial crisis, while home prices are going to fall a lot, even a 25%-30% fall in home prices will only take most buyers back to where they bought in 2019 or earlier, so if borrowers default the banks can recoup their principal.
Energy stocks were the biggest winners in 2022, with total returns of around 60%. So will financials take the reins as the biggest winner of 2023? We’ll see, but I think it’s your best bet. The classic (if a bit overused) Lenin quote is that there are “decades where nothing happens, but weeks where decades happen.” In the spirit of Lenin, bank stocks have gone sideways for years, but Fed hikes should finally bring bank stocks to life.
America’s biggest banks report earnings on Friday, Jan. 13 before the opening bell. Bank of America and fellow megabanks JPMorgan, Citigroup (C), and Wells Fargo (WFC) are reporting earnings Friday, among others. I expect all of these earnings to be good, with the exception of Wells Fargo. Wells Fargo announced that they’re pulling back on the mortgage business, except for existing customers and minority borrowers. Read between the lines here, and Wells Fargo is overexposed to the West Coast housing market, so they seem to be trying to spin a business decision to pull back on loans as social justice. It’s one of the weirder things I’ve seen lately – Wells Fargo has had a tendency to make headlines for all the wrong reasons, the latest being getting fined $3.7 billion for a litany of illegal behavior at the bank in December. Every big bank has to pay fines as part of doing business, but Wells Fargo can’t seem to stay out of trouble.
This said, here’s a quick and dirty guide to bank earnings this week, and I’ll include Goldman Sachs (GS) and Morgan Stanley (MS) which report Tuesday. I’ll also throw in Truist Financial (TFC), a slightly “smaller” megabank that I like for its solid nature and lack of popularity with investors.
Where’s the Value? Megabanks, by Forward (2023) PE ratio and PB Ratio
Bank of America – 9.5x earnings, 1.12x book value
JPMorgan – 10.9x earnings, 1.56x book value
Citi – 7.3x earnings, 0.51x book value
Wells Fargo – 8.2x earnings, 1.01x book value
Goldman Sachs – 9.9x, 1.16x book value
Morgan Stanley – 12.1x, 1.63 book value
Truist Financial – 8.9x, 1.09x book value
So what can we make of this? The first thing that sticks out to me is that bank stocks are cheap. The S&P 500 (SPY) at large is trading for about 17.5x earnings as of my writing this, so the valuations for bank stocks are anywhere from 30%-50% lower than the market. I think this is fundamentally wrong because the market is basing bank stocks’ potential on a zero-rate, QE world when the indications are that those policies will be abandoned as failures going forward.
The second is that within the sector, the market pricing is fairly efficient, with a couple of exceptions. The better businesses trade for higher valuations. Morgan Stanley has the highest valuation of big banks now and has a capable M&A machine that is driving a lot of growth. Citi has problems, but for 7.3x they’re maybe not insurmountable. The return on equity for Citi is a bit at 8%, but they do have some basic level profitability to work with and improve on. Citi might be worth a look Friday. Wells Fargo we got into before, I think it’s trouble and isn’t even that cheap.
The last interesting comparison in my mind is comparing Truist with Bank of America and JPMorgan. The latter two banks are more popular. They have CEOs who go on CNBC regularly, they’re more widely owned by retail investors, etc. Truist has a similar level of ROE to Bank of America at around 10%, but you can pick up the stock cheaper. In the long run, you might make 1% more annually buying Truist, because it’s cheaper and unpopular, but still delivers the goods. There’s long-running academic research that less popular stocks tend to outperform popular stocks in the long run.
How Will Bank Earnings be on Friday?
Bank of America- I think BAC’s numbers will be very good. Analysts expect $0.77 in earnings and have revised down their expectations in recent weeks, but I think they’re being too negative given the basic forces (the Fed) pushing BAC’s net interest margin up. BAC reported $0.81 last quarter, I think they’ll match it this quarter, or maybe report a bit more. There simply aren’t many reasons to expect that the bank will need to make significant boosts to loss reserves with unemployment still so low.
JPMorgan – JPMorgan has the highest expectations of the bunch in terms of valuation, but I think the company will meet them. JPMorgan CEO Jamie Dimon is more bearish on the economy than Bank of America CEO Brian Moynihan, but the bank noted this week that they’re still hiring, in contrast to peers that are laying off. This is likely a signal that Chase Bank continues to do well. Analysts expect $3.10 in earnings for JPM, last quarter the bank smashed analyst expectations, I expect a beat this quarter as well.
Citi – Citi reports as well, and expectations are low. Above, I showed that Citi trades for 0.5x book value. I’m not going to come out here and say that Citi is going to take over the world, but it’s the cheapest stock of the big banks. If you look at their income statements over the last 10 years, it’s not a disaster. Their revenue has grown a bit while their payrolls and expenses have held steady. They’ve been able to steadily decrease their share count, so EPS has gone up. They’re exiting foreign markets where they don’t make any money. There’s nothing really fundamentally wrong with this stock, which is why Warren Buffett bought a few billion in stock last year. Analysts expect Citi to report $1.20 per share this quarter, I think they can beat it as well.
Wells Fargo – WFC stock has more problems than Citibank in my mind, but it’s more expensive. Speaking of Warren Buffett, Berkshire Hathaway dumped their stake in Wells Fargo last year in May, around the same time they picked up Citi. Did Berkshire lose strategic confidence in the management? Or did they think Citi stock was simply tactically cheaper? They’re not going to say it publicly, but my guess is that it could have been a little of both. Analysts expect Wells Fargo to report $1.18 in normalized earnings but only $0.60 in GAAP earnings (more fines). I don’t expect Wells Fargo’s earnings to be particularly bad, but I don’t think their odds of beating expectations are as good as the other three banks.
A CPI Selloff May Provide a Buying Opportunity For Banks
Here’s a setup for investors. I don’t know if you’ll get it, but if you do, I think it’s a nice tactic you can use. CPI comes out tomorrow (Thursday), while banks report on Friday. If CPI comes in hot, the market is likely to sell off heavily, possibly in excess of 3% for the day. This kind of indiscriminate selloff would come at least in part from expectations that the Fed will hike rates more than the market expects and keep them higher for longer. But to this point, a more aggressive Fed would mean that banks could expand their net interest margins even more, leading to better earnings. If there is indeed a tidal wave of selling tomorrow, bank stocks will be your best pickups.
I know what you’re probably thinking. What about the coming recession though? Won’t it crush bank stocks? The 2008 recession did, and unemployment spiked to 10% in the US and even higher in Europe. But in 2000-2002, unemployment peaked at a bit over 6%, even as markets fell 50% from peak to trough. Then, like now, the problem was that many assets were priced far too high, and buyers of assets that were priced well did fine in the end. If US unemployment hits 10%, bank stocks will have been the wrong move. But I view stocks falling 50% peak to trough as 10x more likely than a wholesale economic collapse in the US. Even if the recession is deeper than expected, you’re getting good compensation by buying stocks with low valuations and can hold cash to weather the storm.
Bottom Line
Bank stocks are among the cheapest in the stock market, but have structural factors that are likely to boost their earnings going forward. You can throw darts and do reasonably well, but I would avoid Wells Fargo due to unique issues with the company. Citi is the cheapest bank stock, while Morgan Stanley is arguably the best run. Truist is a dark horse contender, and Bank of America seems a bit undervalued as well. Overall, I expect bank stocks to be among the best performers in 2023.
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hapabapa
The outlook for the broad market is precarious in 2023 due to rate hikes, slowing consumer spending, and popping asset bubbles. But for well-run bank stocks, these aren’t particularly worrying. For one, big banks like Bank of America (BAC) and JPMorgan (JPM) pay 0.01% on checking and savings accounts and can earn 5% simply by investing deposits in Treasury bills. Second, if consumers spend less and save more, then bank deposits may actually rise. Third, while there are many asset bubbles unwinding in the economy, bank stocks are not one of them, as most bank stocks are trading around 10x earnings. Fourth, unlike the 2008 financial crisis, while home prices are going to fall a lot, even a 25%-30% fall in home prices will only take most buyers back to where they bought in 2019 or earlier, so if borrowers default the banks can recoup their principal.
Energy stocks were the biggest winners in 2022, with total returns of around 60%. So will financials take the reins as the biggest winner of 2023? We’ll see, but I think it’s your best bet. The classic (if a bit overused) Lenin quote is that there are “decades where nothing happens, but weeks where decades happen.” In the spirit of Lenin, bank stocks have gone sideways for years, but Fed hikes should finally bring bank stocks to life.
America’s biggest banks report earnings on Friday, Jan. 13 before the opening bell. Bank of America and fellow megabanks JPMorgan, Citigroup (C), and Wells Fargo (WFC) are reporting earnings Friday, among others. I expect all of these earnings to be good, with the exception of Wells Fargo. Wells Fargo announced that they’re pulling back on the mortgage business, except for existing customers and minority borrowers. Read between the lines here, and Wells Fargo is overexposed to the West Coast housing market, so they seem to be trying to spin a business decision to pull back on loans as social justice. It’s one of the weirder things I’ve seen lately – Wells Fargo has had a tendency to make headlines for all the wrong reasons, the latest being getting fined $3.7 billion for a litany of illegal behavior at the bank in December. Every big bank has to pay fines as part of doing business, but Wells Fargo can’t seem to stay out of trouble.
This said, here’s a quick and dirty guide to bank earnings this week, and I’ll include Goldman Sachs (GS) and Morgan Stanley (MS) which report Tuesday. I’ll also throw in Truist Financial (TFC), a slightly “smaller” megabank that I like for its solid nature and lack of popularity with investors.
Where’s the Value? Megabanks, by Forward (2023) PE ratio and PB Ratio
Bank of America – 9.5x earnings, 1.12x book value
JPMorgan – 10.9x earnings, 1.56x book value
Citi – 7.3x earnings, 0.51x book value
Wells Fargo – 8.2x earnings, 1.01x book value
Goldman Sachs – 9.9x, 1.16x book value
Morgan Stanley – 12.1x, 1.63 book value
Truist Financial – 8.9x, 1.09x book value
So what can we make of this? The first thing that sticks out to me is that bank stocks are cheap. The S&P 500 (SPY) at large is trading for about 17.5x earnings as of my writing this, so the valuations for bank stocks are anywhere from 30%-50% lower than the market. I think this is fundamentally wrong because the market is basing bank stocks’ potential on a zero-rate, QE world when the indications are that those policies will be abandoned as failures going forward.
The second is that within the sector, the market pricing is fairly efficient, with a couple of exceptions. The better businesses trade for higher valuations. Morgan Stanley has the highest valuation of big banks now and has a capable M&A machine that is driving a lot of growth. Citi has problems, but for 7.3x they’re maybe not insurmountable. The return on equity for Citi is a bit at 8%, but they do have some basic level profitability to work with and improve on. Citi might be worth a look Friday. Wells Fargo we got into before, I think it’s trouble and isn’t even that cheap.
The last interesting comparison in my mind is comparing Truist with Bank of America and JPMorgan. The latter two banks are more popular. They have CEOs who go on CNBC regularly, they’re more widely owned by retail investors, etc. Truist has a similar level of ROE to Bank of America at around 10%, but you can pick up the stock cheaper. In the long run, you might make 1% more annually buying Truist, because it’s cheaper and unpopular, but still delivers the goods. There’s long-running academic research that less popular stocks tend to outperform popular stocks in the long run.
How Will Bank Earnings be on Friday?
Bank of America- I think BAC’s numbers will be very good. Analysts expect $0.77 in earnings and have revised down their expectations in recent weeks, but I think they’re being too negative given the basic forces (the Fed) pushing BAC’s net interest margin up. BAC reported $0.81 last quarter, I think they’ll match it this quarter, or maybe report a bit more. There simply aren’t many reasons to expect that the bank will need to make significant boosts to loss reserves with unemployment still so low.
JPMorgan – JPMorgan has the highest expectations of the bunch in terms of valuation, but I think the company will meet them. JPMorgan CEO Jamie Dimon is more bearish on the economy than Bank of America CEO Brian Moynihan, but the bank noted this week that they’re still hiring, in contrast to peers that are laying off. This is likely a signal that Chase Bank continues to do well. Analysts expect $3.10 in earnings for JPM, last quarter the bank smashed analyst expectations, I expect a beat this quarter as well.
Citi – Citi reports as well, and expectations are low. Above, I showed that Citi trades for 0.5x book value. I’m not going to come out here and say that Citi is going to take over the world, but it’s the cheapest stock of the big banks. If you look at their income statements over the last 10 years, it’s not a disaster. Their revenue has grown a bit while their payrolls and expenses have held steady. They’ve been able to steadily decrease their share count, so EPS has gone up. They’re exiting foreign markets where they don’t make any money. There’s nothing really fundamentally wrong with this stock, which is why Warren Buffett bought a few billion in stock last year. Analysts expect Citi to report $1.20 per share this quarter, I think they can beat it as well.
Wells Fargo – WFC stock has more problems than Citibank in my mind, but it’s more expensive. Speaking of Warren Buffett, Berkshire Hathaway dumped their stake in Wells Fargo last year in May, around the same time they picked up Citi. Did Berkshire lose strategic confidence in the management? Or did they think Citi stock was simply tactically cheaper? They’re not going to say it publicly, but my guess is that it could have been a little of both. Analysts expect Wells Fargo to report $1.18 in normalized earnings but only $0.60 in GAAP earnings (more fines). I don’t expect Wells Fargo’s earnings to be particularly bad, but I don’t think their odds of beating expectations are as good as the other three banks.
A CPI Selloff May Provide a Buying Opportunity For Banks
Here’s a setup for investors. I don’t know if you’ll get it, but if you do, I think it’s a nice tactic you can use. CPI comes out tomorrow (Thursday), while banks report on Friday. If CPI comes in hot, the market is likely to sell off heavily, possibly in excess of 3% for the day. This kind of indiscriminate selloff would come at least in part from expectations that the Fed will hike rates more than the market expects and keep them higher for longer. But to this point, a more aggressive Fed would mean that banks could expand their net interest margins even more, leading to better earnings. If there is indeed a tidal wave of selling tomorrow, bank stocks will be your best pickups.
I know what you’re probably thinking. What about the coming recession though? Won’t it crush bank stocks? The 2008 recession did, and unemployment spiked to 10% in the US and even higher in Europe. But in 2000-2002, unemployment peaked at a bit over 6%, even as markets fell 50% from peak to trough. Then, like now, the problem was that many assets were priced far too high, and buyers of assets that were priced well did fine in the end. If US unemployment hits 10%, bank stocks will have been the wrong move. But I view stocks falling 50% peak to trough as 10x more likely than a wholesale economic collapse in the US. Even if the recession is deeper than expected, you’re getting good compensation by buying stocks with low valuations and can hold cash to weather the storm.
Bottom Line
Bank stocks are among the cheapest in the stock market, but have structural factors that are likely to boost their earnings going forward. You can throw darts and do reasonably well, but I would avoid Wells Fargo due to unique issues with the company. Citi is the cheapest bank stock, while Morgan Stanley is arguably the best run. Truist is a dark horse contender, and Bank of America seems a bit undervalued as well. Overall, I expect bank stocks to be among the best performers in 2023.
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