My eyes normally cross while reading bank stock quarterlies. Such reports are crammed full with numbers line after line and meaningless comparisons with year-ago stats. There’s nothing exciting going on for banks now excepting recent firming of Treasuries all along the yield curve, from 2 to 30- year paper.
Coincident with firming rates on Treasuries, major bank stock properties, like J P Morgan, Citigroup and Bank of America seem ready to push into new high ground. But, you could get faked out. Over a year ago, net interest margins for banks were expected to pop, but they’ve run flat-to-down. Same goes for loan demand, which has eased steadily despite the more buoyant economic setting.
So, the historic reason for banks, making loans, went nowhere past 18 months. All this while the stock market more than doubled. Non-banking sectors shined, particularly investment banking and trading. Such sectors may be peaking, but rising loan demand with higher rates carry enormous operating leverage for banks.
Historical comparisons suggest bank stock earnings could rise between 10% and 20% on a comparable increase in loan demand at higher rates. The market will pay up for better net interest margins, more than for volatile sectors like trading and underwriting. In such a setting, price-earnings ratios can close part of the discount to the S & P 500 Index. Stands at over 20 times the consensus earnings forecast next 12 months.
Historically, a 20 P/E is a heady number that never has persisted for more than a couple of years. Recessions, galloping inflation and FRB intervention do destroy markets, particularly the financial sector which now approximates 20 % of total market valuation. Only the technology sector is bigger, even more volatile.
There is ample reason for market skepticism on bank stock earnings and their near destruction of net worth from deep loan losses. In the financial meltdown, 2008-’09, I remember buying the Bank of America preferred stock, $25 par value, at 4 bucks a share. Lehman Brothers wasn’t saved while Merrill Lynch got merged into Bank of America around $4 a share.
Citigroup was the most curious case of a major financial property floundering in broad daylight, from its bad loan portfolio and foolish concentration in mortgage paper that self-destructed on fictional asset coverage.
Anyone investing in bank stocks should pull up the long -term chart on Citigroup. The only reason C sells at a respectable institutional price, low seventies, is that in the midst of the 2008-’09 financial meltdown, management performed a reverse stock split that took it from a low single digit ragamuffin price point to a more respectable level.
The only reason to do bank due diligence is to muster your courage to act without inhibition when these stocks are in a freefall. I did this with Citigroup, Bank of America, Goldman Sachs and Las Vegas Sands. In America, at least over the long run, optimism pays. But I’ve learned not to forecast too definitively on interest rates and the valuation structure of the market.
Bank stocks like Citigroup came back from the ashes of 2009, a buck-a-share then before its reverse split of 1 for 10. But consider, too, that Jamie Dimon, carried J P Morgan through the meltdown while the headmen at Citigroup, Bank of America, Merrill Lynch and AIG were shown the door. They carried no risk management in place.
Citigroup in 2001 was the fifth largest capitalization in the S & P 500 at $225 billion. General Electric was numero uno, a market cap of $415 billion that later on slid down to $50 billion. Management over decades made dilutive acquisitions of other banks, credit card purveyors and brokers that fit their grand design as a worldwide provider in financial services. This was a reckless bank, hopefully, changed.
Having said all this, I carry nearly 30% of my portfolio in financials. Namely, J P Morgan Chase, Goldman Sachs, Citigroup got my money. Outsized weighting came from appreciation. Goldman Sachs moved from book value to twice book, past 18 months. Financials remain great hedges against money market rates escalating inexorably.
But, the long -term experience on C is harrowing if owned prior to its reverse split during the financial meltdown. Citigroup topped out well above $500, bottoming near zero early in 2009.
If Citi compounds earnings at 10% per annum, it will take 20 years to fully recover. Wish ‘em luck and pesetas.
Martin Sosnoff owns in his own and managed accounts: Goldman Sachs, Citigroup, J P Morgan Chase