As many economists expected, the Federal Reserve decided not to raise rates at its latest policy meeting. And as other pundits unwind how wise or foolish that is, and what it means for future interest rate moves, it’s worth looking at what the decision actually means for your investments — namely, financials and bank stocks.
The obvious bull case for bank stocks, be they big financials like JPMorgan Chase (JPM) and Wells Fargo (WFC) or smaller players like Regions Financial (RF) or Huntington Bancshares (HBAN), is that higher interest rates will result in better net interest margins for their loans.
It’s not surprising, then, that all of these stocks and many of their peers have been doing poorly over the last month or so as it seemed more likely that the Fed would stand pat and not hike its benchmark interest rate level.
All that said, bank stocks and the financial sector do not live and die based on the Fed alone. In fact, many indicators are looking up for bank stocks right now independent of the interest rate environment.
Here’s why you may want to consider a position in bank stocks now even without a rate increase from the U.S. Federal Reserve — and a few of my favorite picks in the sector:
Cost Cutting Pays Off: Many banks have been doing more with less since the Great Recession, and mid-sized PNC Financial Services Group (PNC) is a great pick to consider to play this trend. PNC has targeted $500 million in cost-cutting this year through layoffs and 100 branch closures, containing costs and ensuring a better bottom line regardless of what the Fed does.
Earnings Momentum: Another stock to watch is regional bank Huntington Bancshares (HBAN), which just saw a record second-quarter profit. Even the megabanks including Bank of America (BAC) saw impressive earnings surprises, with market data firm FactSet reporting that the financial sector was second only to healthcare with the number of companies topping revenue estimates in the second quarter. This, coupled with financial stocks posting an overall earnings growth rate of 6.8% year-over-year, is very encouraging for the sector going forward.
Strength in Mortgages: In August, existing home sales hit the highest level since 2007, according to the National Association of Realtors. The fact that transactions are at pre-recession levels is encouraging for the all-important mortgage lending business of banks. At the same time, foreclosures are at their lowest level since late 2007, meaning borrowers are making good on those mortgages and not just buying houses they can’t afford. Given the importance of this lending segment to banks, strength in housing is a promising sign.
Attractive Share Valuations: After a pullback for many stocks in the last several weeks, bargain hunters have plenty of attractive targets among bank stocks. The current P/E of financial stocks is 14.7, and the forward P/E is just 6.7, according to financial data site FinViz. That makes financial-sector valuations the lowest among any sector. Furthermore, some of the biggest and most entrenched financial services companies are trading for significant discounts to book value. A few picks that are the “cheapest” out there include Citigroup (C), trading at a price/book of about 0.75 right now, and Capital One Financial (COF) at 0.89.
Cyclical Potential: For all the grumbling about China and a strong U.S. dollar and market volatility, the bottom line is that the U.S. unemployment rate continues to drop and consumers continue to spend more money. A 5.1% unemployment rate is the lowest level since 2008, while personal spending and personal income both rose at a nice clip in July despite broader economic uncertainty around the globe. With more people working and spending, that naturally means more business for financial institutions.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.
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