Bank stocks have been horrendous to trade for over a year. There is a general consensus on Wall Street that they can’t hold their rallies. So whether it is a self-fulfilling prophecy or matter of fact doesn’t really matter because the end results is the same: Every attempt to rally ends in tears. So why did I go long Bank of America (NYSE:BAC) stock yesterday? Because this time it could be different.
There are several reasons why bank stocks can’t sustain rallies but the most obvious one is that the yield curve is flattening. This is the side effect of having a loose monetary policy. This recently became worse because the U.S. Fed Reserve flipped its tone to extremely dovish.
When Jay Powell announced recently that the Fed was done raising rates this year and that they will end their Quantitative Tightening it caused a crash in yield and a massive spike in treasury prices. So the yield curve suffered a sudden dip thereby reviving the fears of its inversion.
Why is that important? If the yield curve inverts, then the short-term rates would be higher than the long-term one. And since banks borrow on the short-term overnight lending rates, they would lose money to lend it out, so they won’t do it.
So if the banks stop lending, it would bring the economic expansion to a halt, and experts say it would bring a recession within 12 to 18 months. This caused traders to sell bank stocks fast. BAC 10% in four days
There is hope at the end of this tunnel.
Looking Forward in BAC Stock
The Fed worked very hard for over ten years to bail the global economy out. There is no way they will cause it to fall back into one. So I strongly believe that they will do whatever it takes to prevent the curve from inverting. This is why we now have odds that they will actually cut rates next.
But one thing that all investors agree on is that the bank stocks are cheap. BAC sells at a 10.6x trailing price-to-earnings ratio which is almost at book value. So the market is pricing it at its going-out-of-business price. This is not right, but it does help my cause if I want to go long.
Having bottom book value this close to the current price means there is more upside potential than downside risk. This is a bank that has been forced by the government to have a fortress balance sheet. It is also U.S.-centric, so it carries no risk to foreign entities like say Goldman Sachs (NYSE:GS) for example.
Moreover, its management has been proven competent as they survived the worst financial disaster perhaps of all time. And they have been vetted by the policy makers, so there are very small odds of skeletons in the closet.
So BAC stock looks like a decent long here. I know this is still going against the meme that banks can’t rally, but again, the chart posture combined it with the value below should have more upside potential than downside risk.
Moreover, the bond market has been on an extended run so that incremental risk is mostly gone. Bond prices should be ready to drop bringing some relief to bank stocks. So I can hold BAC stock into its earnings.
Those who prefer using options can buy May calls with a 25 delta so they can risk less and still participate in the rally. This would include the earnings, so maybe investors rally the stock into the earnings and can book it ahead of then. The $27.40 zone is a technical trigger of sorts. This is also a two-year pivot area for BAC stock and those tend to provide support below current levels.
Last night we got news about the departure of the Wells Fargo (NYSE:WFC) CEO. This is providing lift to WFC and BAC stocks this morning because Sloan has been the target of political pressure so him leaving should unshackle the WFC stock specifically and maybe divert political scrutiny off all banks including BAC.
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.