The summer earnings season kicks off in full swing this Friday when a slew of big banks report their quarterly numbers. Wells Fargo & Co (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc (NYSE:C) and PNC Financial Services Group Inc (NYSE:PNC) are all due to report quarterly numbers before the bell on Friday. But WFC stock is of the most interest to me.
You see, going into the reports, investors might be tempted to treat all banks as equals. After all, the stock prices for each of these companies are highly correlated.
But only one of the big banks reporting on Friday is a screaming buy to me, and that’s WFC.
Banks Could Be Big Winners Later This Year
Theoretically, all the tailwinds are in place for bank stocks to sprint forward in the second half of 2017.
Financial stocks have been handcuffed since 2008. Tight regulations have limited banks’ flexibility and creativity, while a persistently low-interest-rate environment has made it tough to grow the bottom line.
But everything is in place for that to start changing.
A tightening labor market should spark higher inflation. Once inflation starts to heat up, the Fed will start tightening and raise interest rates. Once interest rates go up, banks start making more money. Moreover, Trump is working to dismantle the strict financial regulations which defined the Obama era.
All together, deregulation and higher interest rates are two huge tailwinds that should propel bank stocks a lot higher. (Hopes for both are what have pushed financials so hard already since the November elections.)
But the hard data doesn’t really support that theory.
While the American economy continues to add jobs and keep unemployment low, wage growth is struggling. The Consumer Price Index, a key measure of inflation, actually fell in May. Core Personal Consumption Expenditures (or PCE), another key measure of inflation, rose only 1.4% in May. That was the first time PCE growth fell below 1.5% since 2015. The Fed’s target for core PCE growth is 2%, so we are still a ways away from inflation needing to be checked by higher interest rates.
And on Wednesday, Federal Reserve Chairwoman Janet Yellen said that while the economy is doing better and that the Fed does plan to eventually go forward with raising rates, she anticipates rates don’t need to go “all that much further” from here.
Theory and reality are in conflict right now. Eventually, one will be right, and one will be wrong.
If theory is right, and inflation eventually goes higher and sparks multiple interest rate hikes, then bank stocks could be huge winners. Higher interest rates and less regulation is a Goldilocks environment for banks.
But if reality persists, then there are serious risk to bank plays like WFC stock. Maybe the job market falls out, and America enters a recession. Banks don’t do well in recessions. Or maybe inflation never picks up, and interest rates remain low. Banks also don’t do terribly well when interest rates are low.
For these reasons, I don’t like many bank stocks right now. But I do like Wells Fargo.
Only WFC Stock Is a Buy
The only big bank stock worth buying here is Wells Fargo, and that’s because the stock has much to gain if interest rates go higher, but not a lot to lose if the aforementioned risks materialize.
Largely due to internal scandals — the major one being the millions of fraudulent accounts opened, with the scandal coming public late last year — WFC stock has greatly under-performed its peers recently. Year-to-date, JPM is up a little more than 7%, PNC is up under 9%, Bank of America Corp (NYSE:BAC) has rallied just under 10%, and C stock has gained about 12%.
Wells? It’s flat.
But that’s a good thing for new buyers, because it means expectations for interest rate hikes are muted in the valuation.
Yes, Wells Fargo is far less interesting than its peers, but that makes it oh so much safer. The financial titan has largely shunned investment banking and instead focuses on wealth management and mortgages. This more conservative business model can hold WFC back against its peers when the market is volatile, but it should help the stock hold up better during trying times.
Thus, WFC stock sports an attractive risk-reward profile. Higher interest rates are a tide that will lift all boats, Wells included. However, if interest rates remain low and/or we enter a recession, that’s certainly not ideal for the bank, but it should weather the storm better than its peers.
Mitigated downside risk and a simple model make Wells Fargo the best buy in banking right now.
As of this writing, Luke Lango was long WFC.
