I will start today’s write up with a positive note about banks in general. Almost all big U.S. money centers are very cheap from the traditional valuation metrics. That has been true for a long time. This does not mean that they are all a solid bets for more upside. In fact, they’ve earned the reputation that they are unable to sustain rallies. Wells Fargo (NYSE:WFC) closed strong Monday and up more today, but for perspective it’s down 60% from 2018. Short term, I’d rather wait out a few more positive ticks on WFC stock before committing new money. Long term, the stock has better days ahead but they are farther out in time.
WFC is the black sheep of the financials. It has created its own drama for years. It is trying to atone, but meanwhile the regulators are watching it closely. That’s why I like to go long it on dips because it has the most obvious risk.
I’ve written mostly bullish notes on but have warned when downside risk lurks. On big rallies like it’s in, I fear another round of disappointments. This would be the seventh attempt at cracking $28 per share. Onus is on the bulls to prove they can. Otherwise, if they fail then I would catch the falling knife closer to $24.
I’ve always avoided chasing rallies going into prior failure levels. The whole sector is in a similar predicament. JPMorgan (NYSE:JPM) is also battling prior demons lurking around $121 per share.
The strategy is simple, I’d rather buy the WFC stock dip closer to $24.10 or chase the breakout above $28. I don’t want to trust the bulls until they can prove to us that this time it’s different. The presumption is that it will fail again, albeit temporarily. This shouldn’t upset the bulls too much because this is more of a short-term price action strategy.
I hold no long-term commitment to a bearish thesis against the prosperity of Wells Fargo stock. It will be higher in the future if the investors are patient. For now all banks’ income opportunities are suffering from central bank policies.
WFC Stock Is Fighting the Fed
The whole world is stuck in a web of quantitative easing infinity. This means that there is a giant lid on yields. Usually to create revenue growth, banks need room in the margin between what they can borrow at and what they lend to us. These days, those margins are thin, so the upside in their earnings potential is minuscule. Even though they are cheap it doesn’t mean that they can sustain break outs. That’s why the shorter term rallies serve us best when they are purely technical.
Most banks pay great dividends. Wells Fargo has limits from the regulators as punishment for prior sins. It doesn’t make a lot of sense to own for the income. Citigroup (NYSE:C) has emerged as a secondary black sheep this year, so some heat may be coming off WFC.
Once again, my caution today is not a knock against this bank. It is sometimes healthy to play the devil’s advocate when offering an opinion. Simply stated, I like the sector but as a fixed income trade. In the absence of any yield from Bond markets, those seeking safety must own dividend paying stocks.
Show Me the Money?
JPMorgan stock has earned the moniker as of best of the best in the sector. It was a successful short for the last three weeks against its failure near $120 per share. The whole market is rallying on a flip in sentiment. This came about from favorable vaccine headlines from Pfizer (NYSE:PFE), Moderna (NASDAQ:MRNA) and most recently AstraZeneca (NASDAQ:AZN). This is great news for humanity but the fundamentals in the actual earnings of the stocks have not changed. Perhaps prices overall are stepping too far ahead of reality. Even though I don’t believe there is an imminent giant crash lurking, caution is a good idea.
This is yet another level of worry that would stop me from chasing WFC stock right here. We can’t just trade stocks inside of a vacuum. They all trade within the prism of the whole market. The current prevailing meme form pundits is that they favor bank stocks. Consensus is now that yields are brewing a super spike. I caution against chasing such stories. Besides, there is also the matter of the CARES act. A big chunk of U.S. mortgages are in forbearance. These programs will run through Q1 of 2021 and they might bring trouble to large home lenders. Wells Fargo and Bank of America (NYSE:BAC) might be at risk.
Investors have all the tools to do their own homework and use a little bit of logic to avoid potential mistakes. Ideally I like selling puts or put spreads into Wells Fargo stock on bad days. On good ones I avoid chasing them especially when they go into prior failure.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.