After the 2008 crisis, the reputation of bank stocks took a massive hit. The swoon lasted a decade and many big corporates failed before they rebuilt it back up. Consequently, up until late last year, they earned the reputation that they couldn’t hold a rally. They became value traps for investors. They deserved better because Bank of America (NYSE:BAC) did a lot of heavy lifting, gobbling up bad banks before they failed. Without doing so, the carnage in the economy would have been much worse after Lehman failed.
For the last two weeks this idea has been wrong because, Wall Street has fallen back in love with Bank of America stock as it rallied over 20% in a matter of days. But this doesn’t mean that investors need to flock back into it in droves. The point of this write up is to stress the need for homework. There is reason to pick entry points carefully because sustained rallies are still scarce in the sector. Add to it that the overall macroeconomic condition is still in shambles, then caution is indeed a good idea. I take no joy in calling for caution, because the last time I wrote about the stock was bullish and it delivered profits.
Bank of America Stock Is Cheap But That’s Nothing New
I will start with the good news — Bank of America stock is cheap. It has a price-to-earnings ratio of 10, and its stock price is less than its book value. Clearly, Wall Street investors are not giving it much credit, not even for the assets on its books. From that perspective, the rally can last but this is where the story sours a little. Although I agree that bank stocks are worth owning, I don’t believe chasing them here is the right thing to do. The dividend yield is attractive, but shouldn’t be the only reason to buy it. I would rather buy the breakout and target $30 or higher, but not before trigger confirmation. I do believe in the value, but I don’t believe that the upside potential will be easy from here.
To accomplish the best bullish setup with with the least amount of out of pocket risk is to sell puts below to generate income, and buy the breakout for almost free. Simply put, the best Bank of America trades are to use the options markets. There is proven support near the novel-coronavirus-induced low. The trade would then be to sell the Sept. $20 put and collect $1 for it. Then use the proceeds to buy shares or upside calls to participate in the rallies if and when they come. This would leave little money out-of-pocket and the only risk is that the investor would end up owning the shares below $20.
Buy-and-Hold Hasn’t Always Worked for Banks
Buying the shares and holding them for upside potential in the traditional sense has not worked for banks. It took the Financial Select Sector SPDR Fund (NYSEARCA:XLF) 13 years to recover from the financial crisis. And what makes it worse is that they collapsed 43% from there in the blink of an eye. Yes, the quarantine punished all stocks, but the timing for banks was horrendous. All is not lost however, as long as the bulls can find footing and remount the upside push without further damage.
The distance needed to travel back to the neckline near $30 per share is a tall task from here. Specifically, Bank of America stock is now 52% below its October 2006 highs. Even getting back to the failure point of 2020 near $36 seems too far. It will take a few miracles for the bulls to hit that.
The Bottom Line on Bank of America Stock
To make things worse, there is a new big unknown that surfaced in the last few months. Part of the Coronavirus Aid, Relief, and Economic Security Act regarding forbearance sprouted out of nowhere and in the millions. This means that mortgage providers and owners like Bank of America will have to deal with interruptions in payments on a big scale. Although the Bank of America CEO Brian Moynihan sounded reassuring last week on CNBC, I remain very skeptical about believing him at face value. Only time will tell and investors need to be cautious into the next set of earnings reports. There’s complete confusion in the current quarter financials statement of all stocks, so we need more clarity from the next round.
This is all to say that I don’t hate banks stocks now, I just don’t like the idea of chasing upside except for specific technical breakouts. For Bank of America stock, it needs to hold above $24 per share and break out from $26 for it to trigger another bullish extension. Until then, it should chop between those two values. It is also important to note the presence of a gap below $23 per share.
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.