Financials have been among the stock market’s most favored stocks in recent months. The sector even held up well during the February correction. But the stock market is slumping again, and this time, the banks are falling too. JPMorgan Chase & Co. (NYSE:JPM) hasn’t been spared. JPMorgan Chase stock is down almost 10 percent over the past two weeks.
Is now the time to buy the dip on JPM? The company’s track record as a superior bank remains strong. And the valuation isn’t as stretched as it was recently. But don’t overlook the obstacles ahead of the company, either.
Can JPMorgan Chase Stock Stay Above Other Banks?
One of JPMorgan Chase’s defining traits over the past decade is that its management has had more skillful strategic planning compared to peers. Of the nation’s largest banks, only Goldman Sachs Group Inc (NYSE:GS), Wells Fargo & Co (NYSE:WFC) and JPMorgan Chase arguably made it through the Great Financial Crisis in flying colors.
And since then, Wells Fargo has shot itself in the foot with repeated customer service scandals. Over at Goldman, longtime CEO Lloyd Blankfein is retiring this year. That leaves just Jamie Dimon left of the CEOs who successfully piloted their big banks through the financial crisis. What an empire he’s built over the past decade as the other “too-big-to-fail” banks had to take their lumps and concede market share to repair their damaged balance sheets.
For starters, JPM stock is now worth nearly three times what it fetched in 2006, prior to the financial crisis. A fair number of too-big-to-fail banks wiped out nearly all their stocks’ value over the same span. JPMorgan Chase stock, by contrast, put up returns at least as strong as the S&P 500 as a whole during a time when banks badly trailed the market. JPMorgan Chase’s valuation recently reached $400 billion, making it the largest U.S. financial institution — other than Berkshire Hathaway Inc. (NYSE:BRK.B) if you count it — and one of the country’s most valuable businesses outright.
But the financial crisis shouldn’t be forgotten so quickly. Banks that looked powerful collapsed in the space of months. Even JPMorgan Chase got hit with its London Whale trading scandal more recently. Large banks repeatedly wipe out massive amounts of shareholder value. After the huge run in JPMorgan Chase stock, it’s worth asking if the bank has permanently first-class management, or if it has benefited from some good fortune and a few well-timed decisions. Good luck often reverts to the mean after awhile.
JPMorgan Chase Stock Has To Demonstrate Value
JPMogan Chase stock is now trading at just about the highest forward price-to-earnings ratio of its peer group, though all look relatively cheap on that basis. However, I’d argue analysts might be overestimating earnings power across the industry.
On the arguably more useful price-to-book metric, JPMorgan Chase stock is up at 1.7x. That’s up against Morgan Stanley (NYSE:MS) at 1.4x and Bank of America Corp (NYSE:BAC) down at 1.3x. There are plenty of other too-big-to-fail U.S. banks at cheaper ratios. Highlights include now formerly high-flying Wells Fargo at 1.4x, and Citigroup Inc (NYSE:C) still down under book value outright. The also highly-regarded management team at U.S. Bancorp (NYSE:USB) is up at 1.9x, above JPM, but arguably with reason as its loan book is safer. Given those comparisons, JPMorgan Chase has its work cut out for it to maintain a premium valuation on its assets — when you start out paying 20-30% more per dollar of book value than rivals, management has a challenge to meet expectations.
JPMorgan Chase stock bulls will point to the company’s gargantuan asset base as its moat. The company now has $1.4 trillion in deposits — close to 10% of the nation’s gross domestic product. And incredibly enough, JP Morgan isn’t having to pay interest on almost $400 billion of that bounty. That’s a lot of cheap capital from which JPMorgan Chase has generated sparkling returns.
Bears will suggest, however, that the other large banks also have sufficient assets to achieve similar scale. Ultimately, if any one bank grew that much larger than the other top-tier players, federal regulators would probably intervene. Going forward, JPMorgan Chase stock bears say, interest rates will become more competitive. That could be problematic for a bank like JPMorgan Chase that has so many low-cost deposits at the moment.
One of the main reasons that financial stocks have soared over the last 18 months is optimism over rising interest rates. The change in political winds has led to increasing inflation expectations. That leads to more Fed hikes, and, in theory, more banking profits.
Since banks earn money on long-term loans and spend money on short-term deposits (think savings accounts), they tend to earn a fatter spread when rates surge. This interest rate cycle, however, has not played that out yet. The yield curve, which tends to expand as rates increases, has instead contracted. That would ultimately have the effect of lowering bank profits. Now, to be fair, the spread will probably still expand sooner or later, producing a beneficial effect for banking profits. So far, however, the tax cut is doing much more for bank sector profits than the interest rate cycle.
On the other hand, rising interest rates can hurt the banks by slowing down lending activity. It shouldn’t be too hard to see how the average 30-year mortgage going from, say, 4% to 6% would cause housing prices to suffer (borrowers can afford less payment) and cause the housing market to slow considerably. Similarly, consumers tend to pull back on unsecured borrowing if rates surge.
Verdict on JPMorgan Chase Stock
Ultimately, whether JPMorgan Chase earns much more on its loan book going forward probably depends most on whether President Trump’s economic policies work. If wages rise and the economy accelerates, the benefits will outweigh the slowdown caused by rising rates. But if wages don’t surge much, the Fed hikes could stall out the economy. In other words, Fed hikes aren’t necessarily a sure thing for JPMorgan Chase stock.
I’m still not convinced that any of the too-big-too-fail American bank stocks can be seen as safe haven plays. As such, it’s hard to get excited about JPMorgan Chase stock, even after a decent sell-off. It still sells for more than most of its peers, and it’s not sure that valuation premium is deserved. The JPM chart doesn’t look bad; the stock will bounce back sharply if the overall market stabilizes. But as an investment, you can probably do elsewhere in the financials sector.
At the time of this writing, the author held BRK.B stock and held no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.
