There’s no sugar-coating the fact that the past three months haven’t been great ones for Bank of America Corp (NYSE:BAC) shareholders. While BAC stock rallied 33% between the election of President Donald Trump and early March, it has pulled back 12% in the meantime as every aspect of Trump’s agenda has hit a headwind.
Reports from a week ago that Q2 trading revenue was down on a year-over-year basis — as was the case with JPMorgan Chase & Co. (NYSE:JPM) and others — certainly didn’t help the bullish case either.
All of those are sideshow, though. The main event is (still) going to play out over the course of this year, and it bodes bullishly for Bank of America.
Interest Rates Make a World of Difference
All the other facets have been interesting, but they all pale in comparison to the proverbial big Kahuna that owners of BAC stock should have their eye on. That’s interest rates, which should ratchet higher to the tune of 25 basis points when the Federal Reserve gets a chance to put such a change in place on the 14th.
As of the most recent look, traders are betting — with actual money — there’s a 98% chance we will indeed see such a rate increase.
Investors who’ve been keeping close tabs on the bond market may well know, however, that interest rates have been falling of late. Since late December, 30-year Treasury yields have peeled back from 3.18% to 2.85%, while 10-year government bond yields have slipped from a March peak of 2.61% to 2.2% now. In both cases, the interest rates are still in a broad downtrend.
That’s not how it’s supposed to be.
Not only did the FOMC impose a quarter-point rate hike in March, traders are (literally) betting on at least another rate hike in June, and they’re leaning on at least one more bump-up in interest rates later in 2017. The general consensus outside of the Fed-funds futures market is two more increases in interest rates this year.
Nevertheless, market-driven interest rates are tumbling when they shouldn’t be, and it’s the prevailing interest rates that make banking more or less profitable. In general, the higher interest rates are, the greater the spread, or difference, between a bank’s borrowing costs and its lending revenue.
Indeed, BofA threw out some detailed numbers that end last year suggesting 100 basis points worth of higher interest rates could add $6 billion worth of income to Bank of America’s annual bottom line. For perspective, the bank earned $16.2 billion last year; the potential for earnings growth is significant.
It wasn’t empty rhetoric either. When market rates soared late last year in anticipation of this year’s rate hikes, it led to a 43% year-over-year increase in the company’s Q4 income. A huge chunk of that growth was attributable to higher interest rates.
Not Panning Out? Not So Fast.
In that light, the fact that interest rates have fallen in the meantime is understandably concerning to BAC stock holders.
So what gives? The disconnect is what can and does happen when traders are left to their own devices.
When the Fed Funds ticked higher by 25 basis points in December (with at least a couple more penciled in for 2017), the market took that ball and ran a little too far with it. The pullback in yields since then is merely a correction of an overzealous move. Not even March’s subsequent rate-hike from the Fed was enough to halt the corrective move in its tracks.
That may not be the case with the next increase in interest rates though, the first of which could materialize in the middle of this month.
For better or worse, traders have the habit of preemptively and excessively reacting to change. It became clear late last year that a series of rate hikes this year was not only likely, but necessary. The plans were for a slow-and-steady imposition of rate increases though, and not the sudden, all-in-one-shot increases the bond market tried to put in place in November and December.
More often than not, traders learn their lesson. While we can never rule anything out, from here, the market’s interest rates should more or less mirror the direction of the Fed’s foundational interest rates.
In other words, look for roughly 50 basis points worth of higher market rates as this year progresses. That’ll be huge for BofA.
Bottom Line for BAC Stock
It’s admittedly tough to get excited about Bank of America from here. Even if interest rates reverse their downtrend — and there’s no absolute guarantee they will — there’s still the dark cloud of diminished trading revenue hanging over investors’ heads. Where’s the growth?
Patience. The growth is brewing. The Fed’s plans to crank up interest rates this year are in response to an economy that’s finally reaching escape velocity. Though it may not feel like it at times, as a whole, the picture is looking brighter — the Fed’s chiefs know what they see. That economic growth should not only rekindle interest in investing, but also prod the borrowing that banks thrive.
BAC stock is still a healthy play for those who can look beyond one day’s headlines.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
