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3 Big Reasons To Be Cautious on Bank of America Stock

The economy is slowing, rates are going lower and BAC stock has a valuation that's too full

Shares of Bank of America (NYSE:BAC) haven’t gone anywhere for over 18 months now, mostly due to concerns regarding a global economic slowdown. In late 2017, BAC stock was trading hands around $28. Ever since, the global economy has slowed, and investors are concerned it will keep slowing. The price tag on Bank of America stock today? You guessed it. $28.

3 Big Reasons To Be Cautious on Bank of America Stock
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Yesterday’s 2.7% after-hours pop was solely part of a broader bank stocks move after the Fed said BofA was among the 18 big banks that passed the regulator’s stress test, which allows it to boost dividends and share buybacks.

BAC stock hasn’t been this stagnant since 2014-16. During that two-year stretch, similar global economic concerns caused BAC stock to fall flat in the $15 range. How did that era of stagnancy end? With a big rally in BAC stock from $15 in mid-2016, to $30 by early 2018.

And while “past performance is no guarantee of future results,” Bank of America stock investors are wondering if history will repeat itself? Will the now-sideways trading era in BAC stock end with another big rally?

The answer is “no” … because there are three big difference between then and now. Ultimately, those three differences mean that the 2017-19 sideways trading era in BAC stock, will have a much different outcome than the 2014-16 sideways trading era.

As such, when it comes to Bank of America stock, investors should proceed with caution. The next big move in this stock will likely be lower.

US Economy Is Slowing

Back in late 2015, the U.S. economy was hobbling along. Real GDP growth in the third and fourth quarters of 2015 was below 1%. Over the course over the next several years, the economy proceeded to pick up steam. In 2016, real GDP growth started to hover around 2%. By 2017, real GDP growth was in the 2%-plus range. By 2018, we had a few quarters of 3%-plus GDP growth.

To recap, from late 2015 to late 2018, real GDP growth accelerated from under 1%, to above 3%. This acceleration helped support stronger consumer banking activity at BofA, which ultimately pushed BAC stock higher.

The exact opposite is happening today. As opposed to hobbling along like it was in late 2015, the U.S. economy is firing on all cylinders today, at 3.1% real GDP growth last quarter, right in line with the long-term average real GDP growth rate of 3.2%. There isn’t much more room for growth to accelerate. We are already at the norm. Indeed, GDP growth over the next several years is expected to fall to 2% and lower.

Broadly, then, the economy is going from heating up to cooling down, and that’s not a good thing for BAC stock.

Rates Are Going Lower

In addition to economic growth picking up steam from late 2015 to late 2018, interest rates also moved higher during that stretch. The Fed aggressively hiked rates from late 2015 to late 2018, and during that period, the effective federal funds rate climbed from just over 0.1% to 2.3%. This increase provided a tailwind to BofA’s net interest income and overall profits.

That tailwind is now a headwind. The consensus on Wall Street is that the Fed is going to start cutting rates. Thus, for the foreseeable future, the effective fed funds rate is going to drop. That means lower net interest income and overall profits for BofA.

Broadly, then, we are going from an interest rate hike environment, to an interest rate cut one, and that pivot spells more bad news for BAC stock.

BAC Stock Valuation is Full

Back in 2016, BAC stock was trading at just over 0.5-times its book value, versus a five-year average book multiple of 0.9x. Thus, the valuation was low enough to support a big rally in BAC stock through both profit growth and multiple expansion.

The opposite is true today. Bank of America stock isn’t trading at a discounted book multiple. Instead, it’s trading at a premium book multiple of over 1x. Thus, there really isn’t much room — if any — for multiple expansion over the next several years. Instead, there’s room for multiple compression, meaning that the risk-reward profile on BAC stock now skews sharply to the downside, especially in light of the aforementioned slowing growth and rate cutting headwinds.

Bottom Line on Bank of America Stock

Bank of America stock has had two periods of prolonged sideways trading over the past decade: from mid-2014 to mid-2016, and from mid-2017 to mid-2019.

The mid-2014 to mid-2016 sideways trading era ending with a huge rally, since coming out of 2015, U.S. economic growth accelerated higher, interest rates went up, and BAC’s multiple expanded. The mid-2017 to mid-2019 rally should produce an opposite result, since coming out of 2018, U.S. economic growth sill slow, rates will go lower, and the multiple will compress.

Overall, then, investors should proceed with caution. Bank of America stress test results aside, BAC stock does not look good here and now.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media,

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