Editor’s note: This column is part of our Best Stocks for 2017 contest. Ken Trester’s pick for the contest is Citigroup Inc (NYSE:C).
The financial stocks — represented by the Financial Select Sector SPDR Fund (NYSEARCA:XLF) — have been on an absolute tear since Donald Trump was elected President of the United States, as you can see from the chart below.
Expectations for less regulation on the banks and higher interest rates sometime in the near future have pushed the financial sector higher by an eye-popping 19% since early November on volume far greater than we have seen for most of 2016.
Click to Enlarge However, while you might expect that these stocks have run too far, too fast, one of the biggest names in the space is actually presenting quite the value play.
Citigroup Inc (NYSE:C) is my pick for the Best Stocks for 2017 contest for several reasons, including its low price/book value ratio, expectations for higher interest rates over the near term and an improving technical picture that could send the stock much higher.
Citigroup is Relatively Cheap
Compared to four of its peers — JPMorgan Chase & Co. (NYSE:JPM), Goldman Sachs Group Inc (NYSE:GS), Bank of America Corp (NYSE:BAC) and Morgan Stanley (NYSE:MS) — Citigroup has the lowest price-to-book value ratio, coming in at 0.8. BAC is trading in line with its book value, while JPM, GS and MS are all trading with price to book values of 1.2 to 1.3, indicating that they are relatively overpriced when compared to Citigroup.
When I recommend stock options to my subscribers in Maximum Options and Power Options Weekly, I always make sure that I am focusing on undervalued, or cheap, options that provide the biggest profit potential, and that is the same approach I am taking now.
Since we are looking for a stock that is going to perform well over the next full year, finding one that is undervalued at current levels is key. The regional banks are likely to move higher as well, but C stock has been a laggard amongst its peers lately, so I’m betting that it will make a stronger recovery.
One of the factors that has been keeping Citigroup down is that it has a lot of international exposure. With foreign currencies all weakening due to the strength of the U.S. dollar (USD), the international picture is not looking good for the banks right now.
However, I think the dollar has gone too far at current levels, so if other currencies begin to strengthen against it, that would be a big help for C stock. With the British pound down to ~1.25 and the euro almost at parity against the dollar, it should flatten out eventually, although I cannot provide a timeline for when that might happen.
Also, international exposure is not always a bad thing. In Citigroup’s case, its Mexico unit (Citibanamex) is the country’s second-largest bank and acted as a much-needed cushion during the U.S. financial crisis.
Sure, investors started throwing out their Mexico exposure when Donald Trump got elected — but I think that is ridiculous. Trump is not going to do much to Mexico, period; eventually, Wall Street will realize that. And in the meantime Citi is investing in reaching both wealthy clients and the “unbanked.” More than half of the Mexican population doesn’t have a bank account, making it a huge potential growth market for C stock.
Citigroup also carries a far lower forward price/earnings ratio than its peers. For example, JPM, GS, BAC and MS currently show forward P/E ratios of 13.4, 13.9, 14.8 and 14.2, respectively, whereas C is trading at a much lower 11.6 ratio.
Most stocks, even outside of the financial sector, are either fairly or fully priced, but I don’t think Citigroup is at current levels, so its share price still has room to move higher.
Less Regulation and Higher Interest Rates
The picture for the banking stocks has greatly improved when we consider the possible impact of a Trump administration on financial regulation. Currently, the Dodd-Frank Act requires Citigroup to hold a large amount of capital relative to its assets, which has limited the amount of leverage it can use and, therefore, its ability to turn a profit.
Trump has promised to roll back such regulations, and that could lead to increased lending by C stock and the rest of the banks. However, the other factor that is needed to boost lending is an increase in interest rates.
The problem with the banks is that they’re just not going to give out loans at the current low rates. I find myself asking why a bank would choose to finance a 30-year mortgage if it’s only going to return 3.5%-4%. It doesn’t make any sense. They’re simply not going to loan at these levels, so higher interest rates are going to be key for the banks going forward.
What Citigroup stock needs is for the yield curve to steepen, meaning that the long-term rates they collect would be higher than short-term rates they are loaning out. If that happens, the profit picture for the banks will improve pretty dramatically, and they should be more willing to lend.
As a personal anecdote, I tried to get a mortgage several years ago through one of the big banks, and it never panned out. Basically, they were not interested, as they need higher rates to make it worth their while.
This means the rate hike announced at the Federal Open Market Committee (FOMC) this week is a good start.
I also believe the U.S. economy will grow next year, and possibly for many years after that, which therefore implies higher rates in the future. Higher rates should also improve dividend payments. C stock doesn’t have a very high dividend yield compared to its peers, so there is room to grow in that area as well.
The Technical Picture for C Stock Is Bullish
On a technical level, Citigroup is also looking quite bullish. On the three-year weekly chart below, you can see that the stock has gone to battle with resistance at the $50 level multiple times, but it broke higher through that level following the presidential election and is now challenging upper resistance at about $60 per share.
The stock reached this level in mid-2015 as well, but it was soundly rejected and went on to decline nearly 45% into the beginning of 2016. It has since completed its round trip back to the $60 level, having appreciated by more than 70% from its 52-week low of $34.52 that was set in February.
While C stock is facing stiff resistance at $60, under the right circumstances that I’ve outlined above, I do think that shares could break through that level in 2017 and keep going.
Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990. And, in Power Options Weekly, he delivers 5 new options trades and his latest trading advice to you each Friday. It’s the perfect ‘bridge’ between investing in ordinary stocks and the turbocharged world of options trading.
Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990. Try Power Options Weekly today and receive 2 weeks for the price of 1 for only $19.95.
