Clearly I won’t gain any fans sharing a negative note about Wells Fargo (NYSE:WFC). After all, bank stocks are recent darlings on Wall Street … at least for the last two weeks. However, this steep ramp is cause to avoid new longs in Wells Fargo stock, but not for intrinsic reasons.
The rally in the sector has come largely from a huge rip in yields. Bond prices have collapsed, so rates rose and the perception is that this benefits the financials and so the chase was on. The Financial Select Sector SPDR Fund (NYSEARCA:XLF) and JPMorgan (NYSE:JPM) are up over 35% in just about two weeks, while Wells Fargo is up 50%.
My problem is that this is not the first time they caught a bid and usually they can’t sustain it too long. I am not a hater of the space. In fact, I always condone buying the dips in bank stocks. Most mega banks are great companies with bulletproof balance sheets. They have a ton of value, very little froth and they pay dividends to boot. But they are not the bunch to chase on rip-roaring rallies like one would chase in Tesla (NASDAQ:TSLA) or Shopify (NYSE:SHOP). Besides, there is a rally in bond prices brewing and that is a headwind for bank stocks.
The Resistance Wall for Wells Fargo Stock
So far, the rally has been much stronger than normal, but investors should be in no rush to initiate new positions into Wells Fargo’s stock just as it approaches $34 per share. This was a big failure point in early March and April. Furthermore, this also marked a top on Friday. It’s up to the bulls to take this out and reprogram the algorithms to trade off $34 as support, not resistance. You’ve heard it before that prior resistance becomes forward support. Well for that to happen here, the buyers need to overcome said overhead selling pressure.
More to this point, Well Fargo stock has been struggling with the $30 zone since 2006. The stock finally sprang from that zone in 2013 to rally almost 100% to its 2018 all-time high. The crash into the quarantine low was brutal, but only about half of it was from the novel coronavirus crisis. The banks were already in free fall from the 2018 correction. To state it simply, for the same reason Wells Fargo found support at $22, it will find resistance into $34 (see chart).
There Is Extra Covid-19 Risk for Mortgage Issuers
Fundamentally, Well Fargo is not expensive with a price-to-earnings ratio of 11. Its stock price is only 0.80 times its book, so investors are not even giving it full credit for its assets. Nevertheless, this alone is not a reason to buy it because value is almost never an issue from the absolute sense. It is the relativity to its own history that bothers me. I used the charts and the technicals to determine the best approach. Together they suggest to wait and buy-the-dip closer to $30 per share or chase the rip above $34.
Part of the stimulus CARES act is the forbearance portion. Borrowers can stop payments on their monthly obligations with a simple click of a button. All they need is to simply state that they have been negatively impacted by Covid-19. This will surely add a heavy load onto the bank financials and the reckoning is about 90 days from now. Most forbearance plans are for three months, so homeowners will need to pay back the amounts they differed. At that time, if they didn’t save, they will be in another, deeper hole. Most banks have loan loss reserves for defaults, but the scope of the unemployment situation is too big of a wild card to ignore the potential of this nasty setup. This problem also exists in the commercial space.
Last week’s job report was extremely strong and perhaps too strong. I am a numbers guy and such discrepancies should raise doubt about the data integrity. The way the government calculates the report is from 70,000 phone calls, so there is a lot of room for mistakes. This is not a situation where a system spits out the stats based on actual data. There is a lot of room for human error. Anyone who answers that they are not looking for work yet is unemployed doesn’t count. The report is reflective of the pool of people looking for work. Overall, caution is still warranted regardless of the recent flip in sentiment.
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.