The recent rally in the Bank of America (NYSE:BAC) stock price has been a surprise. Starting early last month, Bank of America’s stock soared over 20%, and touched a post-financial crisis high.
Admittedly, in one sense the gains in BAC shouldn’t be a surprise at all. In early October, BAC stock was as cheap as it has been in years (and maybe ever) on an earnings basis. Third-quarter earnings in mid-October came in nicely ahead of expectations. BofA and JPMorgan Chase (NYSE:JPM) have been my two favorite big bank names. The 20%+ gains seem like a rally that was long overdue.
But it’s the timing of the rally that was a surprise — at least from here. After all, all those conditions largely have existed since the beginning of 2018. Earnings have been strong. Valuation has been reasonable. The economy has been solid, with low unemployment reflected in significantly reduced charge-offs and delinquencies.
Despite those positives, Bank of America stock has struggled. At October lows, the stock was down almost 10% from where it traded at the beginning of 2018. External factors — notably interest rate worries and cyclical concerns — had kept a lid on the BAC stock price. And while I was bullish long-term, I argued just ahead of the rally that the sideways trading would continue, largely due to those external factors.
Obviously, that analysis was wrong. Now, the question going forward is if Bank of America stock can surprise once again. It might be tough for it to do so.
Why Has BAC Stock Rallied?
Again, there are two broad reasons to suggest that Bank of America stock should be relatively cheap at the moment based on both earnings and book value. First is the cyclical risk. Banks like BofA are obviously sensitive to macroeconomic factors. And in year eleven of a U.S. economic expansion, investors have worried off and on that the economy is “due” for a stumble.
Second, interest rate expectations continue to come down. That, in turn, pressures net interest margin for big banks, including BofA. It also suggests pressure on profits or at least minimal growth going forward.
As far as the cyclical risk goes, BAC stock isn’t the only name where investor optimism has clearly risen. Classic cyclical names like Caterpillar (NYSE:CAT) and Deere (NYSE:DE) have rallied. Home Depot (NYSE:HD) broke out despite macro risk before tanking after earnings. Industrial stocks have also bounced, with the Industrial Select Sector SPDR Fund (NYSE:XLI) climbing over 10% in about seven weeks.
But on the interest rate front, the news actually doesn’t look all that positive. The Federal Reserve cut rates for a second time in September. That should have been a concern for the likes of BAC and JPM, and indeed the cut interrupted a modest bounce in both stocks. But after digesting the news, investors decided that BofA still could keep earnings intact — and maybe even growing — in a low interest rate environment that seems likely to persist for years to come.
How Bank of America Stock Performs Going Forward
The problem at the moment is that Bank of America stock needs the market to stay similarly optimistic in terms of both risks. Right now, that isn’t the case. Cyclical fears seem to be popping up again.
Other cyclical names have also softened in recent sessions. The trade war still hovers over the market, and the economy. A contentious 2020 U.S. presidential election looms, and could cause consumers on either side of the political divide to pull back on spending.
On the interest rate front, meanwhile, the news simply seems like it’s not going to get better. If interest rates are being cut now, it’s hard to imagine under what circumstances they’d be raised again.
In other words, after the rally, Bank of America stock still seems to be stuck in the same spot it has been. Long term, the stock can rise. A 2.2% dividend yield helps the case. But short-term, BAC still relies on the market taking on cyclical and interest rate risks.
For a few weeks, the market was happy to do so, and Bank of America stock soared. For it to soar again, or even hold these gains, that external optimism will need to continue.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.