I despise parabolic moves in anything, whether it be bitcoin, or tulips, or the Nasdaq, or oil, or blockchain, for that matter.
I particularly don't like parabolic jumps, the kind with the huge slopes up, when it comes to slower-growing groups because that just cries out "unsustainable."
Yet that's exactly what has been happening with the bank stocks over the last few days -- parabolic moves that can't be justified by the fundamentals.
So, do you need to sell the banks? Do you need to trim them?
The most imperative dictum in stock investing is much like the ultimate imperative for a doctor -- first, do no harm, which I always have translated, loosely I admit, into, "No one ever got hurt taking a profit." Our Action Alerts PLUS portfolio sold some Citigroup Inc. (C) yesterday when it was $75 and change simply because we were up so much that I felt piggish. Bulls make money, bears make money, but hogs get slaughtered. These rules do not get repealed during a romp like the bank stocks are having. It's the opposite; they are embossed on my forehead like the yellow Post-it note we used to wear in that exact spot if we screwed up.
I can imagine Karen Cramer taping a Post-it to my forehead saying, "I didn't take profits in Citi when I had them and I deserve nothing less than total contempt." Thank heaven those Post-its were never stapled, but they can make for awkward stares when she would make me walk outside to get her a fresh hot pretzel. It's all in "Confessions of a Street Addict," if you really care.
Anyway, when I look at these bank stocks I know they can't keep going up with this velocity. More important to ask, though, is, "Where should they be valued?" Are they galloping to where they ultimately are going to trade, or is this just an outlier move that can be repealed when earnings are reported seven weeks from now?
That's really the questions, and it's a lot harder to answer because the group is controlled by the Fianncial Select Sector SPDR (XLF) , the ETF that traders use to blast in and out of the sector. It most certainly is the tiny tail that wags the big dog, an ETF with a capitalization that isn't even a tenth of the largest bank stock in it, that of JP Morgan Chase & Co (JPM) .
The homogenization makes for some rather difficult judgments for a group that's considered pretty much of a commodity controlled by the Fed and its short-rate tool for stimulating or cooling the economy.
Of course, the homogenization makes no sense because some of these stocks are dramatically undervalued on certain metrics -- Citigroup on tangible book, which is barely below the current stock price; Goldman Sachs Group Inc. (GS) , which is two multiple turns below its average from before the Great Recession; and Bank of America Corp. (BAC) , which has a higher price-to-earnings ratio than most, but its earnings have been depressed by so many different restrictions put on it by the Fed.
Now, if you ask me where the XLF should be, I can justify at least another 5% move, conservatively, based on the belief that we could get four hikes within the next year, including a December bump-up. That's about a concomitant increase to the revenues that come from these hikes, with Bank of America being the biggest beneficiary because it has the largest deposit base.
Bank of America's stock is the most interesting object lesson here. It sells at 15 times earnings versus an average of about 12 times in the years before the Great Recession, so it seems classically overvalued. But when the Fed takes the rates up, the bank will take your borrowing rate up but not move up your CD rates anywhere near commensurately with the Fed's moves. No lockstep here.
Now consider some history. Bank of America's stock traded at $54 back in 2006 before the crash. It has about 4.4 billion shares outstanding. Now it has 10.4 billion. It paid out $2.40 in dividends going into the Great Recession. It currently gives you 35 cents, which is up nicely from 12 cents in 2014 but way below what it has the capacity to pay even with the explosion in its share count.
Here's the hard part: The XLF will make this stock trade with JPMorgan, which is far more expensive, and with Goldman Sachs, which is now historically incredibly cheap versus the crash. But I could easily argue that if you strip the regulations that were piled on during the President Obama era, the earnings power goes up much more than people realize and so does the buyback and the dividend. So it is very difficult to argue that Bank of America is expensive. I can extract different ratios for different bank stocks, but all come out the same except for JP Morgan. They are too cheap to worry about versus both before the deregulation era began under Trump and before the Great Recession.
My conclusion: You can trim them, but unlike so many other areas where stock valuations are historically stretched, a look at this group says you have room to run, maybe much more room to run now that the sector is out from under a punitive regime by a different, and I mean really different, government.
