Fear Of Recession Is Hurting Bank Stocks; Time To Take Advantage?
Haris Anwar | Aug 20, 2019 11:54
Recession or no recession, we already have one casualty of this fear on Wall Street. And that’s banking stocks.
A lingering threat to the global economy due to the U.S.-China trade war and central banks cutting interest rates globally means that the companies that lend money are at a great disadvantage. A potential slowdown, or an economic contraction, will reduce their income on lending while their large corporate clients postpone their expansion plans.
These negative sentiments are already hurting banks as investors shun stocks that are cyclical and closely tied with the health of the global economy. The KBW Nasdaq Bank Index has fallen 15% in the last 12 months, and half of that weakness came in the past few weeks as bond yields began to sink and policy makers became more dovish about growth prospects.
KBW NASDAQ Bank Index price chart
Looking at their valuations, it’s not difficult to gauge investors’ mood. The market is valuing bank shares as if the economy is headed toward recession for sure. The KBW price-to-earnings ratio of about 10.29 is near the lowest levels versus the S&P 500since 2008.
“There is no way to sugar coat risks to banks,” said Mike Mayo, head of U.S. large-cap bank research at Wells Fargo (NYSE:WFC), in a recent note, highlighting his firm's decision to cut earnings estimates and price targets for more than a dozen banks. “No large bank is immune. If interest rates stay at this level, the earnings will get hurt.”
h2 Strength in Consumer Lending/h2But the sour mood around banking stocks doesn’t mean that investors should paint all the names with the same brush. Shares of some of the largest lenders have become attractive after years of restructuring efforts, within a more robust regulatory environment. In this space, we particularly like Citigroup Inc (NYSE:C) and JPMorgan Chase (NYSE:JPM) & Co (NYSE:JPM).
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While the weakening economy is certainly bad for their M&A, trading, and corporate lending businesses, banks that have large and diversified portfolios will stand to benefit on their consumer lending, such as credit cards and mortgage financing. That strength was visible during the second-quarter earning season.
Growing consumer lending was behind the higher quarterly profits at JPMorgan Chase (NYSE:JPM) and Citigroup Inc (NYSE:C)., while Goldman Sachs (NYSE:GS) Group Inc (NYSE:GS), which lacks a big consumer operation, was the only large U.S. bank to report lower profit than it did a year ago.
At JPMorgan (NYSE:JPM), credit card spending rose 11% to $192.5 billion, while balances rose 8%. The bank, the largest U.S. lender by assets, said most of the growth was from existing customers rather than new accounts. Similarly, Citigroup (NYSE:C) reported the purchase volume on its nearly 35 million branded credit-card accounts in the U.S. increasing 8%, while balances rising 3%.
Their consumer strength is also reflected in their share performance relative to their peers this year, with Citigroup (NYSE:C) up 24% in the period, and JPM gaining more than 12%. Citigroup closed yesterday up 1.3% at $64.30, while JPM closed up 0.9% at $108.72.
JPM/Citi price charts
Our view is that both lenders are well-prepared to cope with any cyclical downturn due to their sustained cost-cutting during the past decade and re-balancing of their portfolios. Their efforts are beginning to pay off and both have been producing strong growth in revenue and profit over the recent quarters, as well as offering a decent dividend yield, with JPM at 2.9% vs the industry average of 2.7%, and Citi at 3.1%.
Bottom Line
It's certainly not a good time to go long on banking shares when macro headwinds are gathering pace. But in the case of prolonged weakness, we recommend investors get ready to cherry pick some solid banking stocks. For such investors, we like both Citi and JPM, given their diversified portfolios, growing dividends and improving balance-sheet quality.
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