Since early 2018, on four separate occasions, Bank of America (NYSE:BAC) stock has traded up to at least $30 per share. Each time, the BAC stock price has subsequently dropped. For its loyal shareholders, however, this should be the time that Bank of America finally breaks through overhead resistance and continues to run.
Why’s that? Three things are now working in Bank of America’s favor: Yields are going the right way, the recession scare triggered by the yield curve inversion has faded, and the bank plans to retire a huge load of BAC stock in coming quarters. Let’s dive in.
Stock Yields Surge
All summer, bank stocks had been slumping. It wasn’t hard to see why. Bond yields kept going down and down. Both overseas and at home, yields dropped to multi-year — in some cases all-time — lows. This is bad news for banks, who prefer higher interest rates, all else held equal.
Banks have already been paying depositors next to nothing on savings and checking accounts for years. So they get little benefit from rates going down because they aren’t going to save money on their funding costs. Meanwhile, the rates they can charge on mortgages and other loans plunged.
However, it appears that we’ve hit an inflection point. Over the past two weeks, the 10-year Treasury Yield has gone from a trough under 1.5% to nearly 2%. That’s the equivalent of two 25-basis point Fed rate hikes worth of movement. Similarly, the 30-year yield has gone from 1.9% to 2.4% over the same stretch.
That, in turn, will allow banks to make similar adjustments to their mortgage and other long-term loan rates in coming weeks. This will lead to a higher net interest margin (NIM) for banks in general and Bank of America stock in particular.
Goodbye Yield Curve Inversion
On a related note, the infamous yield curve inversion has gone away. Well, to be technical, it’s mostly gone away, depending on which parts of the yield curve you look at in particular. In general, however, long-term interest rates are now higher than short-term rates. This is the normal state of affairs, and has both a positive effect on the general economic outlook and the banking sector’s earnings. It’s no coincidence that BAC stock has taken off as the yield curve reverted.
There’s also the sentiment factor to consider. The media loves scary headlines, and the yield curve inversion was a good one. As they so frequently said, yield curve inversions, historically, have almost always been followed by recessions. And that’s true. But generally a recession takes 12-18 months to arrive following a yield curve inversion. The fact that rates inverted this summer means we shouldn’t expect a big economic downturn until at least fall 2020.
On top of that, there’s a decent chance the yield curve indicator won’t work this time. Yes, I know it’s risky to say “this time is different.” However, in the past, far fewer people watched this indicator for a sign of recession. Now, with everyone talking about it, policy-makers — including the Fed — have adjusted, easing monetary conditions aggressively to offset the potential danger.
The fact that everyone saw the yield curve inversion and started planning for it could mean it won’t have the predictive power that it used to when it wasn’t a commonly-watched recession indicator.
In any case, the yield curve is already back to a healthy normal state and is getting steeper (which is better for BAC stock) with almost every passing day. It’s still worth watching as conditions could worsen on this front again. But for now, it seems people got overly worried about it.
Bank of America Stock-Specific Upside
While you can make a great case for the banking sector in general — and I’ve bought bank stocks heavily this summer — let’s turn to BAC stock in particular. The most appealing thing about BAC stock is its massive capital return.
As you may know, the Fed has been limiting the amount of dividends that large banks can pay as a portion of their profits. This has allowed banks to offer reasonable dividend yields; BAC stock is offering 2.4% at the moment. Rivals like Wells Fargo (NYSE:WFC) and JP Morgan (NYSE:JPM) are offering 4.2% and 2.7% respectively. However, these are fairly small portions of their overall earnings, as the big banks are trading for 10x earnings or less. That means they have earnings yields of 10%+ and could theoretically pay dividends that size as well if regulators didn’t constrain them.
So, instead of paying large dividends, what are banks doing with the capital? Huge share buybacks. In the case of BAC stock, the bank announced a plan to repurchase more than $30 billion, or close to 12% of the total outstanding share base.
Think about that for a second. All else equal, even if net income is flat, Bank of America’s earnings go up double digits next year simply due to the much smaller outstanding share count.
BAC Stock Is a Strong Buy
The share buyback alone makes Bank of America stock a compelling play. Earnings should rise 10% or more even assuming flat underlying conditions thanks to the share buyback. Now consider that the yield curve is starting to play into Bank of America’s favor. The worst of the net interest margin squeeze is finishing up, and they should be able to drive some growth there as well. With the overall economy healthy, there should be plenty of opportunities to make new loans too.
If these favorable trends continue, Bank of America should be able to boost its operating income while at the same time sharply reducing its share count. This will lead to earnings growth in the teens. That, in turn, should power strong upside in BAC’s stock price once the technical resistance goes down. Look for $35 a share on BAC stock shortly, with it quite possibly hitting $40 in coming months.
At the time of this writing, Ian Bezek owned WFC stock. You can reach him on Twitter at @irbezek.