On Wednesday I listened to a downbeat discussion of bank and brokerage stocks on CNBC’s Half Time.
The investors that own them on the show were dour and disappointed. None expected near term relief.
The trader who was shorting Financial Select Sector SPDR Fund (XLF) today, against his bank of America (BAC) and Goldman Sachs (GS) longs, is also giving up on the group. He noted his unwillingness to be net long in the face of second-quarter reports and with an inverted yield curve and a recession ahead.
The hopelessness expressed by the panelists should not be surprising considering that the month of June was the KBW Nasdaq Bank Index’s second worst June on record (-13.3%), as well as its ninth worst month all time.
At the core of my optimism regarding financial stocks is my expectation of a mild and brief recession. And the outlook for traditional banking remains quite strong.
For me, it’s the time to be an opportunistic buyer during the potential bottoming in the non traditional — capital markets, trading, investment banking – financial industry fundamentals that I expect. Remember, in both banking and brokerage, the value is the customer base — the industries’ deposit/asset bases are “sticky.”
Lower Stock Prices Are the Ally of the Rational Buyer
Once again, The Divine Ms M’s (Real Money’s Helene Meisler) quote applies… “price has a way of changing sentiment.” Rather than leaving the consensus of negativity and taking advantage of a possible opportunity, most remain more comfortable in a herd.
I choose to be outside the herd for financial industry negativity and to join the more bullish ranks with Berkshire Hathaway’s (BRK.B) Warren Buffett, who raised his bank holdings dramatically in the first quarter of 2022.
I couldn’t, respectfully, disagree more with the above consensus and negative assessment on the space — and I have been aggressively buying the recent weakness.
My advice? Beware of rear-view mirror analysis that invokes sour sentiment and lower stock prices:
1. I want to own brokerage stocks when the consensus has embraced the notion that capital markets activity (stock trading volume and investment banking) are weak and will weigh on profits. It is likely discounted and I see the possibility of an improving trend in the next few months.
2. I want to own bank stocks when the yield curve is inverted and fears of a deep recession represents the consensus. It may also be discounted.
3. Not reflected in the historically low valuations, the large money center banks have high and improving quality, predictable and sustainable than trading and investment banking — profit streams which are now benefiting from rising net interest income and elevated and relatively sticky retail deposits:
4. As to yield curve inversion, long duration mortgages are no longer as dominant on bank books, short-term loans and investments are. Therefore, asset durations have been shortened, lessening the impact of an inverted curve.
5. With solid balance sheets and large technology expenditures, U.S. banks and brokerages have deepened their moats by expanding their franchises and market shares at the expense of non U.S. financial institutions and emerging fintech players that have materially disappointed their stakeholders.
6. Remember, some inflation is good for banks as nominal growth is more important than real inflation adjusted growth! Nominal buoys loan, asset and deposit levels.
7. As to the brokerage stocks, I am also optimistic. Though their earnings are more volatile than the traditional bank group, both Goldman Sachs (GS) and Morgan Stanley (MS) have demonstrated an ability to earn a decent return on their capital. GS is trading near book value. As to MS, I am buying a very large retail customer franchise at a low premium to tangible book value (TBV) — and though market prices will vacillate, those retail investors are “sticky.”
Earnings Reports Begin Next Week
I expect few negative or positive surprises in July’s second-quarter earnings releases.
The recent lift in interest rates (NII) will be the strongest supporting feature of the second-quarter reports.
Capital market and mortgage related revenues/profits are already known to be weak — and for obvious reasons: market price declines, slowdown in home turnover, weak investment banking.
Credit costs will be rising somewhat (quarter over quarter) but still very low loss rates and reserve builds. Some loan loss normalization is expected over the next 12 months.
Lower stock prices are the friend of the rational buyer while higher prices are the enemy!
In many ways the negative consensus view — partially in response to weak sector stock prices and the currently low RSI readings, low stock prices relative to tangible book, etc. — is at the polar opposite of the enthusiasm expressed for energy stocks in early June discussed in an earlier post — when the RSI was dramatically elevated and right before the floor fell out for oil stocks.
More importantly, macro clarity — a mild and brief recession (my baseline expectation) — could provide an ideal environment for bank and brokerage stocks.
My advice is to be opportunistic and to avoid the rear-view mirror, the consensus and the downbeat emotions that are the natural byproduct of lower prices.
Banks and brokerage stocks are not a trade, in my view.
Rather, I am embracing the weakness in financial stocks — with an eye on a multi-year investment that could take the group much higher when fears of a deep recession recede.
(This commentary originally appeared on Real Money Pro on July 7. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass’s Daily Diary and columns from Paul Price, Bret Jensen and others.)