Bank stocks have been on a tear this year. But the rally looks to be in the early innings, giving investors ample time to buy shares.
In early 2020, the double whammy of low interest rates and a weak economy crippled bank profits. But late last year, the promise of new vaccines to combat Covid-19, coupled with the steepening yield curve, sent shares soaring. Bank stocks today trade roughly where they did a year ago, with the
KBW Bank Index
up more than 16% this year, outpacing the
With such a swift jump, investors on the sidelines can’t be blamed for wondering if they missed out, but there are still plenty of opportunities near- and longer-term, due to both market dynamics and fundamentals. Despite the recent run-up, the SPDR S&P Bank exchange-traded fund (ticker: KBE) has gained just 9.6% in the past 12 months, trailing the S&P 500 by 7.4 percentage points.
Rising yields and higher economic growth expectations have helped drive shares higher. But bank stocks should also benefit from buybacks, which the Fed permitted again following a brief halt, as well as the eventual release of loan-loss reserves into earnings.
Last year, the largest banks were saved by a surge in trading and capital markets activity. Pure-play investment banks such as
Goldman Sachs Group
Morgan Stanley (MS)
posted record profits, driven first by a jump in fixed-income trading in the earlier part of the year, and then by a flood of initial public offerings and the resumption of mergers and acquisitions later in 2020.
Some may wonder how the banks will fare given the tough comparables they face from last year. There are signs that some of that momentum can continue. While the volatile trading that roiled stocks like
AMC Entertainment Holdings
(AMC), and BlackBerry (BB) was initially portrayed as a retail phenomenon, larger institutional investors and hedge funds also participated in the trading, likely increasing activity at investment banks, at least for the first quarter.
Goldman and Morgan Stanley should also continue to benefit from an increase in M&A as low interest rates provide a favorable deal-making climate. Then there’s the pandemic, which has forced businesses to rethink their strategy, causing some to consider buying and joining with others.
Data from Goldman shows that there was a 100% year-over-year jump in M&A activity in January, with the energy sector being the only one that saw a drop in activity. Global deal-making is strongest in utilities, health care, and technology.
Initial public offerings have also proven to be robust, with 56 new offerings having priced this year, raising a combined $21.7 billion, marking year-over-year jumps of 180% and 331%, respectively, according to Renaissance Capital. That activity bodes well for banks like Goldman, Morgan Stanley, and even
Yet Goldman and Morgan Stanley have other levers to pull even if capital-markets activity abates. Goldman is in the early stages of a yearslong effort to build out its consumer banking offerings. Just this past week, it unveiled Marcus Invest, a digital investing platform geared to retail investors. Goldman, at $315.62, trades at 10.5 times forward earnings, slightly above the bank’s five-year average but below its high of 13.8, which is roughly where some peers currently trade, according to FactSet data.
Morgan Stanley, meanwhile, largely accomplished its pivot to more predictable, fee-revenue businesses a few years ago, but investors can still look forward to synergies from the bank’s recent acquisitions of E*Trade Financial and
to propel shares. Morgan Stanley, at $76, currently trades at 13 times earnings, which matches its peer group but is below the bank’s five-year high.
“Goldman Sachs and Morgan Stanley are undervalued and not appreciated by the market,” Steven Chubak, managing director at Wolfe Research, recently told Barron’s. “Over the last year, the gap really started to widen.”
For investors hoping to do more than bet on a heightened IPO market, there are compelling reasons to look at
Bank of America
(BAC). BofA is one of the larger banks more sensitive to interest rates, implying more upside as the economy improves.
“It’s cheap relative to history,” Chubak said. The bank currently trades at $34.54, or 13.8 times forward earnings, putting it in line with peers but above its five-year high of 16.1. “As you start to normalize for rates and credit, you’re talking about a stock with a $40 handle,” he added.
Investors could also get exposure to the sector by buying into the
SPDR S&P Bank ETF
and forgoing stock-picking. But either way, with capital markets activity looking to remain robust in the near term and the economic recovery under way, banks look like a compelling opportunity.
Write to Carleton English at [email protected]