There are a few reasons to consider going long Bank of America (NYSE:BAC) now. In fact, investors can make a case for owning many financial stocks near current levels. Bank of America stock, JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS) and others are all high-quality names with low valuations.
But for whatever reason, the stocks have yet to get the jumpstart we need. As a result, there are a few pros and cons to owning Bank of America stock right now. Let’s look at them.
Low Valuation for Bank of America Stock
Growth and valuation create a simple argument for owning BAC, JPM and others. Currently, Bank of America stock trades at less than 12 times this year’s earnings estimates. That’s below the average P/E ratio for the S&P 500 Index and by most accounts, is a trademark to a “cheap” stock provided it has growth.
And growth it has. Bank of America is expected to expand earnings a whopping 38% this year, while revenue is expected to grow 3.1%.
So what’s the “con” to this situation? One could make an argument that BAC and other banks deserve a lower valuation, since they aren’t as profitable as they were back in the heyday of banking. Mortgage approvals are harder, trading revenues are lower and fees are smaller. A number of fintech solutions are making it cheaper and easier for consumers to spend, finance, invest and save their money.
That’s one reason to justify a lower valuation for the industry. As for growth, we’re more than halfway through 2018. While there’s great growth this year, earnings and revenue growth decelerates to “just” 13.7% and 4.7%, respectively.
I personally won’t make the case that BAC stock is a sell based on back-to-back double-digit earnings growth with a sub-12x P/E ratio. But others will and so far, the bull case hasn’t caught on as well as some had hoped.
Rising Rates… Right?
Rates continue to rise, as the Federal Reserve attempts to get back to a “normalized” level of interest rates. Later this month, the Fed is expected to hike interest rates again. Could BAC stock rally into the event? It’s possible, especially if the overall market helps out.
Beyond this month, investors are currently pricing in a 77% chance that the Fed will again raise rates in December. If it boosts rates this month and has supportive language to December, those odds will tip higher. If the Fed unexpectedly doesn’t hike, those odds will tumble.
However, there is a downside. While companies like BAC can make more (essentially risk-free money) as rates rise thanks to customer deposits, profitability is being pinched. That’s as short-term rates continue to rise while longer-term rates are less sensitive to the Fed’s hike.
This is known as the “spread” and as it continues to shrink, the banks make less money. So as Fed rates continue to rise, this spread may continue to shrink, hurting BAC and others’ margins. Again, another pro/con.
BAC Stock Chart
Click to Enlarge
The third pro/con is the chart.
On the pro side, Bank of America stock made a beautiful breakout over downtrend resistance (black line). We called that out in July as part of our Top Stock Trades ideas. It’s also positive to see shares holding up over the 100-day and 200-day moving averages, as well as the $30 mark.
However, shares have been coiling for six weeks now, between the two blue lines on the charts. This was the perfect opportunity for bulls to rally it back over $31 and give BAC stock a chance to making new highs going into Q4.
Instead shares broke below the wedge and now we have a short-term bearish reaction, on a chart with a bullish outlook over the intermediate term. That may bode well for cost-averaging investors, but traders are surely frustrated with BAC stock on the long side.
Let’s see how Bank of America trades into the FOMC meeting on September 25 and 26. Will it be a sell into the event and buy afterwards, or a buy-the-rumor, sell-the-news event? We’ll see soon.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell is long JPM and BAC.
