2018 was a difficult year for Wall Street, and for bank stocks like JPMorgan Chase (NYSE:JPM). Stocks had started out the year with an incredible rally, only to correct sharply twice. But they didn’t fall on bad economics. In fact it was two employment reports that were too strong. Both the February and October corrections were triggered by wage data that was too hot. This triggered two panic sell signals from investors fearing how the U.S. Federal Reserve might react.
One of the Fed’s mandates is to control inflation, and a tight labor market where demand overwhelms supply for job is a cause for concern. The fear is that the Fed would need to accelerate its rate hike cycle which would crimp growth.
So it is no surprise that the toughest sector trade this year has been the banks. They are at the heart of the inflation fears. The Fed only controls the overnight lending rates, and that is what banks need to be low.
And as they raised rates, the long-term rates fell behind the hike cycle. This brought about an inverted yield curve where short-term rates are higher than the long ones. We are still teetering on the edge depending on which bond duration we compare. The two-year yield did get higher than the five-year yield but just below the 10-year yield.
In an inverted yield curve, the incentive to borrow short to lend long term becomes a losing proposition to banks, so they won’t do it. Without that, growth in the economy would slow down and we fall into a recession within months. Or so is the current meme.
As a result, great bank stocks like JPM stock and Bank of America (NYSE:BAC) are selling almost at a discount to their book value at times. This is to say that investors see absolutely no value for any future growth. This is unusual for banks that have fortress balance sheets, but perhaps the scars of 2008 financial implosion are too deep and fresh.
Add to this that the new Fed Chair Jerome Powell has recently invoked added concerns that they will overshoot in their tightening targets even if they see the data deteriorate. Investors are confused because there seems to be a disconnect between the Fed Chair and his Vice Chair. They have recently delivered the opposite sentiment twice in the past month. So who to believe?
To Try or Not to Try with Bank Stocks
So are banks stocks worthy of owning? Yes, especially great companies like JPM. In spite of all the headline fears, the macroeconomic conditions are still vibrant. In fact the two corrections in 2018 started because things were too good. So we are currently in a crisis of sentiment not fundamentals.
JP Morgan is regarded as the creme-de-la-creme of banks and it rarely gives investors specific reasons to sell the stock. Case in point JPM stock is 30% better year-to-date than the Financial Select Sector SPDR ETF (NYSEARCA:XLF), and 50% better than the SPDR S&P Regional Banking ETF (NYSEARCA:KRE). So that is proof that it still is the bank stock of choice for investors.
The only problem is that JPM stock is burdened by the current meme which does not allow for banks to sustain rallies for long. The 2018 consensus is that the financials cannot rally. But they are tied to the general markets, and when this Wall Street malaise passes the banks will rally once more.
But just like banks cannot rally alone, the stock markets in general cannot go far without them. So the indices are stuck in a catch-22 where one needs to make the move. This coming quarter has a lot of opportunities to break the cycle of bad news but it is still full of potential potholes. So caution is definitely warranted.
Bottom Line on JPM Stock
Yes, JPMorgan stock will be higher in the long run but I fail to see the reason to make a big bet on it right now. Having said that, it is fundamentally cheap enough now to make the downside scenario smaller than the upside potential. Starting a new position here will work out for the long term, but it may require patience. It took these stocks 10 years to recover from the 2008 disaster.
Although I don’t see a similar one brewing, it does serve as an extreme example for those tempted by values. If the banks are rallying then so are all the equity markets, and I’d probably prefer to put more eggs in hyper growth stocks like Amazon (NASDAQ:AMZN) or Salesforce.com (NYSE:CRM). Of the banks, I would choose to own JPM stock for balance. If markets correct another 10% from here it will probably hold up better than the momentum stocks.
The experts on Wall Street agree that JPM stock has upside from here but the timing is in debate. They are split between buy and hold even though it is trading 20% below their average price range. So they are saying that there is no rush to own it here, even though it should have more upside in the long run.
Technically, JPM stock is now back to a 50% retracement of the 2016 election rally. This is also a pivotal level from February of 2017. These tend to be support on the way down. But even if the markets in general correct another 10%, JPM still has three similar levels at $85, $80 and $75 per share. And that would be pricing out the entire Donald Trump rally from November of 2016.
Click here and enjoy a free video and more of my market thesis and get an ongoing free copy of my weekly newsletters. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.
