Bank of America Corp (BAC) Stock Is at Risk to Secular Technology Trends

Lower interest rates are here to stay, and that means BAC stock has plenty of risk

Bank of America Corp (NYSE:BAC) stock, along with the rest of the financial sector, rallied after Donald J. Trump was elected President of the United States in November 2016. Promises for deregulation and hopes for inflation (which bring higher interest rates) meant the future of banks was brighter than it had been since before 2008. Investors got excited. They bought up the whole group. From Trump’s election to his inauguration, BAC stock rallied about 33% versus a 6% gain for the S&P 500 Index.

Bank of America Corp (BAC) Stock Is at Risk to Secular Technology Trends
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But the hype has cooled. Deregulation is taking a backseat to healthcare issues. Meanwhile, inflation hasn’t really shown up in the U.S. economy despite a tight labor market. Consequently, interest rates remain depressed. The 10-Year Treasury Yield, which went above 2.6% in December 2016 as investors priced in higher inflation expectations, now sits just above 2.2%.

The net result for bank stocks like Bank of America is just performance in line with the broader markets. Since Trump’s inauguration, BAC stock has risen 4%, a little under the S&P 500.

The unfortunate truth, though, is that in-line performance would be a blessing for Bank of America stock going forward. The more likely scenario is that BofA continues to underperform the S&P 500.

Here’s why

The “Trump Bump” Made BAC Stock Expensive

The “Trump Bump” shot Bank of America into a territory that naturally priced in higher interest rates. Over the past 5 years, pre-Trump BAC stock never traded above $20 or 0.9-times its book value. Today, post-Trump BAC stock trades at nearly $24 and roughly 1-times its book value.

Clearly, more is priced into BofA than has been in recent memory. Some of that is deregulation, but a big factor of that is investors betting that interest rates have nowhere to go but up. After all, the unemployment rate is at historical lows, the jobs market is heating up and fiscal stimulus is on the way.

But that is where the market is wrong.

Interest rates aren’t going up any time soon, and that’s a serious risk to Bank of America, which is as richly valued as it has been since the 2008 Financial Crisis. If anything, interest rates will head lower in a long-term window and so will BAC stock.

Bank of America Won’t Go Up Because …

Interest rates aren’t going up, and there are two reasons why: technology and Amazon.com, Inc. (NASDAQ:AMZN).

As I have detailed in two previous articles (here and here), Amazon is suppressing inflation almost all by itself. The e-commerce behemoth has become so large that its low prices are creating a persistently promotional retail backdrop for everyone else to operate against. In essence, most retailers either have to close their doors or lower their prices (with exception to niche, luxury brands). This pricing dynamic is depressing consumer goods prices everywhere and killing inflation.

Advances in artificial intelligence and automation mean that this dynamic isn’t going to change. The Amazon effect is forcing companies to emphasize cost-cutting over risk-taking (they have to preserve margins). That means that a priority of companies today is take costs out of the system. What is one way to do that? Fire employees. And companies can now realistically do that because technology is at a point where automation is a real thing.

All this means is that although the job market is full right now, huge swaths of that labor market are at serious risk to being wiped out by automated technologies. Because Amazon’s presence is being felt far and wide, companies won’t hesitate to start implementing automated technologies.

The net result is a lower for longer interest rate environment.

Bottom Line on BofA

Lower for longer is here to stay. That unfortunately means that BofA has nowhere to go but down.

BAC stock is now more richly valued than it ever was over the past 5 years. Clearly, deregulation and higher interest rate expectations are priced in.

But as the labor market unwinds due to the pervasive implementation of job-replacing technologies, those higher interest rate expectations will likewise unwind. So too will the hyped up valuation on BAC stock.

I say avoid BofA so long as the valuation remains rich against an automated technology backdrop.

As of this writing, Luke Lango was long AMZN.


Article printed from InvestorPlace Media, https://investorplace.com/2017/08/bank-of-america-corp-bac-stock-risk-technology/.

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