While the world is still reeling from the crisis that the novel coronavirus has brought upon the world, bank stocks are reporting earnings this week. The reactions even after some short pops have been very disappointing to the bulls. For example, this morning Morgan Stanley (NYSE:MS) is under pressure on its scorecard. Today we argue for catching the falling knives that are worthy of buying.
To properly frame things today, it’s important to note that I wrote about the opportunity to buy the banks mid March. What followed was a nice 20% rally in mere days. Therefore, this is a rinse-and-repeat effort to re-engage in great companies under selling pressure. What caused the fall is nothing unusual. The story is the same for bank stocks. They report earnings and investors punish them regardless.
The following three bank stocks will be the focus of today’s analysis:
The world is under quarantine, so everything is on hold. Yesterday, we learned that German Chancellor Angela Merkel will start reopening Germany earlier than expected. Other countries will follow, but this is to simply say that eventually this too shall pass and these companies will go back to working soon enough.
Bank Stocks to Buy After Earnings: JPMorgan (JPM)
I am always a fan of JPM stock, especially on big dips. I am not alone with this opinion because the consensus on Wall Street is that Jamie Dimon’s banks is the best of the best, even all the way back to 2007. This week, JPMorgan had the misfortune to report earnings first and investors didn’t like what they saw. Since then it has had three days of selling and it is now almost 15% below the Friday high.
In hindsight, the trade was to sell the strength into the earnings and some of us wrote about this. But therein lies the opportunity, because we now know a good base to buy the stock. Those who missed the rally from two weeks ago have a chance to get on board. For the same reasons that JPM stock failed near $104 per share, I can speculate that it will find support as it falls into $84. Both zones are pivots and the price will slow down going into them. This makes last week’s range the one to trade short term, and any breach of either sides of it will have momentum in that direction.
The fundamentals of JPM are bulletproof and any weakness in its stock performance is extrinsic. Either expectations are unrealistic, or the markets in general are falling. For the long term, starting longs in it here is not likely to be a major financial mistake, so it’s a sound investment. There is little fat to trim, so it’s not over-valued by any stretch of the imagination. From a trading perspective, the stock may encounter resistance as it tries to take out last week’s top. The way around this is to use options. My favorite way to get long shares is by selling puts below current price. This way, you are long, but with a big buffer from the current price.
Bank of America (BAC)
Bank stocks went too far last week ahead of earnings. The hyper bullish sector action made little sense, especially for BAC stock. As it rallied into $25.50 per share, it became a short-term sell. That is a very volatile level and a recent pivot from early March and many times in the past. This made it vulnerable for a dip because machines — that now are responsible for over 80% of all trading — love using prior pivots for reference points. After yesterday’s -6.50% drubbing from its earnings report, the stock is in a buy-worthy target area.
Like most bank stocks, BAC is cheap, but that alone is not a reason to buy it. But it does offer investors the peace of mind to know that they are not buying froth. Furthermore, thanks to the regulatory and procedural changes after the financial crisis Bank of America now stands on impeccable financial footing.
Technically the range to watch short term is between $20 and $25.5. This is a wide band, but that’s the byproduct of having a VIX stuck at 40. Even what used to be a boring stock is now seesawing this much in a short period of time. And therein lies an opportunity. Buying BAC stock now for the long term is a viable thesis. Alternatively and instead of risking the capital and hoping for a rally, an investor can sell the January $19 BAC put. For this they collect almost $2 per contract today. That would be the maximum potential profit, but then if BAC falls another 15% from here, the trade is a winner. The breakeven point to this comes at $17 per share. Compare this with the fact that the traditional method would put money at risk right now and with no room for error.
Wells Fargo (WFC)
WFC stock is the black sheep of the bunch. For the longest while, Wells Fargo was the poster child of successful banks. Then, in 2016, the bloom fell off this rose as we learned of fraud. Employees of the bank were cheating by creating fake accounts to doctor performance reports. The scandal temporarily broke the stock’s momentum even though the bad practices were local and not part of policy. To Wall Street it was a strike they couldn’t ignore, but that too is in the past. After two and a half years of battling the regulators, then CEO Timothy Sloan left the company and the bank turned over a new leaf.
With new management investors buried the hatchet and the stock went on to reach new highs in January. Alas, WFC stock, as with all bank stocks, is well off its highs now. But there was good news for Wells recently: Last week regulators eased their grip on it. The Federal Reserve lifted some of the restrictions that it had on it after the scandal. This may be its exit from the scandal purgatory.
Today, the opportunity is to catch this falling machete almost 60% off its highs. Not a lot has changed for its financials, but sentiment among investors is in the dumps. The whole world is still in quarantine and risk appetite is all but dead. The bottom line is that the WFC stock fundamentals are great. It has a price-to-earnings ratio of 10 and sells at 0.75 of its book value. So investors are not even giving it credit for its assets to its stock price. Therefore, buying it here is not likely to be a financial debacle. Risking capital on quality stocks during bad days has always been a winning strategy, especially when the stocks are cheap.
In addition to their value and technical opportunities, banks stocks have an additional magnet to investors. Most pay a hefty dividend. Billions will seek the payouts since the U.S. Federal Reserve is committed to zero rates and the rest of the world to negative rates. These banks have bullet proof balance sheets and they are not in need of bailouts, so unlike airlines, the dividends are safe. There is potential risk from loan losses if the quarantine persists, but the White House is flooding the streets with cash to prop up business and that helps the banks indirectly.
Nicolas Chahine is the managing director of SellSpreads.com. Join his live chat room for free here. As of this writing, he did not hold a position in any of the aforementioned securities.
