Shares of Bank of America Corp (NYSE:BAC) have gone through a quick reversal. After flaming out over $25 just one month ago, BAC stock now finds itself trading with a $22 handle. Investors aren’t sure whether to double down or sell with both hands and head for the hills.
For now, neither is the best approach.
BAC stock is up just 5% in the first nine months of 2017. That’s none too impressive to most investors during the rest of the stock market’s bullish run. However, keep in mind that after an election-fueled rally, BofA is still digesting its large move higher.
Shares went from $16.50 the night before the election to more than $20 just a few days later. That tells you what investors are expecting when it comes to President Trump. Without hashing out all the details, they are expecting lower corporate taxes, lower banking regulations and an improving economy.
The improving economy has a two-fold benefit for BAC. As the economy improves, more loans are taken, more houses are built and more banking services are used. That adds to Bank of America’s core businesses, but don’t forget about the Federal Reserve. As the economy improves, the Fed continues to raise rates in an effort to normalize interest rates. Essentially, it’s a risk-free boost to BofA and its net-interest margins. While small to the rest of us, higher rates can add billions to BAC’s bottom line.
In December 2015, the Fed — mistakenly, in hindsight — raised interest rates off of the 0% mark. It didn’t budge rates for another year, again hiking by 25 basis points in December 2016. They didn’t stop there, boosting the Fed Funds Rate to 75–100 basis points in March 2017 and to 1% to 1.25% in June 2017.
A Deeper Look at Bank of America
Ahead of the most recent rate hike (in June) by the Fed, many investors were talking about possibly two more hikes later this year. This would bring the total to four in just the past year, assuming the Fed were to raise rates in September and December. However, odds of a September rate hike plummeted from above 90% to about 10% inside of a fortnight after a meeting last June.
This didn’t crush JPMorgan Chase & Co (NYSE:JPM), Goldman Sachs Group Inc (NYSE:GS), Citigroup Inc (NYSE:C), BofA or Wells Fargo & Co (NYSE:WFC) the way many would have thought. Most of these stocks declined ahead of the meeting. In other words, the bad news was priced in.
For the Fed’s part, they said in the June meeting they expect to raise rates one more time in 2017 and three times in 2018. The market’s on a different page though since it has forecast just one rate hike in the next 12 months.
As if the timing of a September rate hike wasn’t intimidating enough — stocks don’t tend to perform very well in September and October. Plus, two major hurricanes in the South and a bevy of forest fires in the West are sure to temporarily stun the economy.
In any regard, the December rate hike odds continue to fall as well. After the July CPI report was released in mid-August, the odds of a rate hike for the month fell from 40% on Thursday Aug. 10 to 32% on Aug. 11. Those odds are just a little lower now at 31.3%, but stood over 90% just a few months ago. In fact, for March 2018, investors are now pricing in a 60% chance that rates won’t have increased from current levels. In June 2018, those odds only fall to 51%.
How Does This Impact BAC Stock?
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A 50-50 coin toss that rates won’t move for another nine months has clear implications for the banks. Without higher rates, the higher profitability many of us were expecting diminishes. That’s not to say the economy won’t continue to strengthen or that business won’t improve — they should. It’s just that this is taking some wind out of the BofA sails.
That’s why BAC stock has gone from $25 to $23, an 8% fall inside of a month. I don’t think BAC will fall to $20 because of rates (although a broad-market decline could cause it to). The company still has strong fundamentals and an attractive valuation. The bank continues to improve, and it’s worthy of investors’ dollars. Some are even calling for a run to $30. And, over the past 12 months, Bank of America is up 46% — an impressive run, no doubt.
So here’s what we do. If I was long BAC stock, I wouldn’t bail. However, if I’m looking to initiate a new position, I would wait. $22 has been massive support. If it falls close to that level, BAC stock is a buy. On a close below $22, we’ll have some questions.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
