A couple of weeks ago, I wrote about the fundamental problems that are weighing down Bank of America (BAC) stock. The biggest issue is that banks continue to suffer from compressed net interest margins (NIMs) in such a low-interest rate environment.
Low margins mean little room to grow profits, which is the primary consideration for any long-term investor. However, if BAC’s NIM and earnings have stagnated, one would expect the share price to do the same.
However, as the chart below indicates, even though BAC’s EPS is at its highest level since the financial crisis, Bank of America stock has tanked 28% in 2016.
A sell-off of this magnitude goes far beyond “stagnation,” so there must be something more at play with Bank of America stock than just the performance of the core business.
Sell the News…and BAC Stock?
The first source of selling pressure for BAC stock is likely a “sell the news” reaction to the Federal Reserve’s modest first interest rate hike in December. Let’s face it: After years of speculation about a rate hike, the December decision caught very view people off guard, which was likely Fed’s intention.
That said, a highly-anticipated piece of news such as this often marks a short-term top in a stock. Naïve investors buy the stock ahead of the news anticipating that the news itself will propel the stock higher. However, by the time the news is finally official, there are no more buyers left, and disappointed traders are quick to dump the stock, driving share prices down. There was likely plenty of post-hike “sell the news” trades in BAC stock.
Investors Fear the Unknown
Post-news selling can account for a lot of the selloff in BAC stock, but a look at Bank of America’s forward P/E ratio of only 7.3, its lowest level in more than a decade, indicates that there is likely something more in play. That something is market fear of the unknown.
What do BAC stock owners have to be scared of? First, 2016 global economic weakness, particularly in China, may end up delaying the Fed’s intended rate hike schedule in 2016 and beyond. It’s too early to be certain, but the improving NIM environment that BAC shareholders had been anticipating may be on hold for now.
Secondly, as if near-zero interest rates were not bad enough for banks, a growing number of countries have been experimenting with sub-zero interest rates. Nineteen European countries, including Denmark, Switzerland and Sweden, have already tested negative interest rates. Just last month, Japan joined the negative rate club as well. The U.S. has never ventured into negative rate territory, and the impact that such a move would have on banks like BAC is unclear.
Basically, despite the fact that the Fed has given no indication of cutting rates below zero, investors are likely becoming uneasy about the fact that negative rates are becoming more commonplace around the world.
Finally — and this is important — despite the fact that the big bank balance sheets are healthier than ever, rhetoric about breaking up the “too big to fail” banks or converting them to utilities has been heating up again lately. Democratic presidential hopeful Bernie Sanders, Massachusetts Senator Elizabeth Warren (D), and new Minneapolis Federal Reserve President Neel Kashkari have all been openly expressing their desire to break up the banks for the good of the country. While it may sound unlikely, these are powerful people.
Bankrate recently found that the majority (58%) of the American public is in favor of breaking up the big banks as well. This type of public rhetoric has likely spooked many investors and could be one of the main reasons why BAC stock and shares of rival Citigroup (C) have majorly under-performed the rest of the financial sector in 2016.
Bank of America: The Bottom Line
Yes, Bank of America’s core banking business has not rebounded as well as investors would have hoped following the financial crisis, but the sell-off in BAC stock this year seems to be pricing in more than simply stagnant earnings growth. It’s difficult to quantify the risk that political and/or monetary policy poses for big banks in coming years, but the market does tend to assume the worst in cases of uncertainty.
For investors that believe that market fears about the breakup of the big banks and/or a future U.S. trip into negative rate territory are a bit excessive, BAC stock certainly seems to offer a compelling “buy the dip” opportunity at around $12/share.
As of this writing, Wayne Duggan was long BAC.