Bargain or trap? US bank stock outlook hinges on Fed's path
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[November 11, 2023] By
David Randall
NEW YORK (Reuters) - Bargain hunters are swirling around beaten-down
shares of U.S. banks, even as skeptical investors say the sector’s
problems are likely to persist for some time.
The S&P 500 bank index is down around 11% in 2023, a year that began
with the failure of Silicon Valley Bank and several other lenders in the
worst banking crisis since 2008. The broader S&P 500, by contrast, is up
around 15%.
Bank stocks are at an all-time low compared with the S&P 500 based on
relative prices, according to data from BofA Global Research. That
tumble has made their valuations attractive to some investors: the
sector trades at eight times forward earnings, less than half of the
19.7 valuation of the S&P 500.
"Right now, you can't say for sure whether the attractive valuations are
merely a value trap,” said Quincy Krosby, chief global strategist at LPL
Financial, referring to a term describing stocks that are cheap for good
reason.
One key factor for bank stocks is whether the Federal Reserve is close
to wrapping up a monetary tightening cycle that has brought the highest
U.S. interest rates in decades.
Elevated rates allow lenders to charge customers higher interest. But
they also increase the allure of short-term bonds and other
yield-generating investments over savings accounts, while hurting demand
for mortgages and consumer lending.
Few investors believe more rate increases are in store. Yet signs the
Fed may keep rates around current levels through most of next year have
weighed on bank stocks. Nevertheless, some contrarian investors appear
to be moving into the sector: the Financial Select Sector SPDR Fund
received net inflows of $694.59 million in the week ending on Wednesday,
its best weekly showing in more than three months.
This month, analysts at BofA Global Research said investors should
“selectively” add exposure to bank stocks in anticipation of an interest
rate peak. Most risks to the sector stem from higher rates, they said,
including margin pressure due to rising deposit costs and problems with
commercial real estate.
Famed investor Bill Gross said last week he believed the sector had hit
bottom and added he was holding a number of regional bank stocks,
fueling sharp rallies in their shares.
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Traders work on the floor at the New York Stock Exchange (NYSE) in
New York City, U.S., October 27, 2023. REUTERS/Brendan McDermid/File
Photo
"We think there is a lot of hidden value in banks if you are
selective," said Neville Javeri, a portfolio manager at Allspring
Global Investments who is overweight banks relative to the S&P 500
in the portfolios he manages.
Javeri believes larger banks have significantly cut costs and are
poised to raise dividends and increase buybacks, helping them
weather a period of slower loan growth.
Among stocks recommended by BofA's analysts are shares of Goldman
Sachs and Fifth Third Bancorp.
Investors are awaiting U.S. consumer price data next week, for a
glimpse of how the Fed is faring in its fight to keep lowering
inflation from last year’s multi-decade highs. A sharper than
expected fall could bolster the case for the central bank to cut
rates sooner.
Many investors and analysts remain pessimistic on bank stocks.
Historically high mortgage rates have weighed on lending. Overall,
about 61% of all outstanding mortgages have an interest rate below
4%, according to the Apollo Group, leaving consumers little
incentive to refinance or move. The average contract rate on a
30-year fixed-rate mortgage dropped in the week ended Nov. 3 by a
quarter percentage point to 7.61%, the lowest in about a month.
Meanwhile, analysts have been cutting growth estimates for
financials, which includes not only banks but insurance companies,
as the Fed maintains it will keep rates higher for longer. This
could hurt mortgage loan growth.
The financial sector is expected to post earnings growth of 6.2% in
2024, nearly half of prior estimates from April that showed 11.4%
earnings growth, according to LSEG data.
"You don’t have any certainty that you’ve seen the worst of it and
things are getting better," said Jeff Muhlenkamp, lead portfolio
manager at Muhlenkamp & Company.
(Reporting by David Randall; Additional reporting by Bansari Mayur
Kamdar; Editing by Ira Iosebashvili and David Gregorio)
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