Amid talk of a value resurgence and expectations that cyclical sectors, including financial services, will rebound with Joe Biden in the White House, there’s some recent momentum for bank equities. For example, Wells Fargo (NYSE:WFC) is higher by 11.09% for the month ending Nov. 16, but that’s not an endorsement of WFC stock.
Even with that recent pop, WFC stock is lower by more than 53% year-to-date, a stunning outcome relative to the widely compared KBW Nasdaq Bank Index, which is off “just” 20.18%. Said another way, Wells Fargo is an egregious offender in a group full of them and it’s standing out for all the wrong reasons.
Weak stocks in weak places usually aren’t great bets, but it’s worth examining why that sentiment applies to Wells Fargo. Consider some of the broader issues facing all banks, not just Wells Fargo. Prime among those woes are low interest rates, which crimp banks’ net interest margins — the spreads at which money is loaned out and interest paid on deposits.
Decades of market history confirm bank equities are positively correlated to interest rates. However, that’s unlikely to happen anytime before 2023 because the Federal Reserve needs to keep monetary policy accommodative owing to the novel coronavirus pandemic.
Other Challenges for WFC Stock
Believe it or not, it’s not difficult to find market participants that are bullish on bank names and/or the broader value universe, of which financial services stocks represent a significant percentage.
The value boosters are clinging to hope that this time really will be different as the investment has teased for years, only to lag growth by wide margins. They point a growth/value chasm that’s as wide as it’s ever been. Value may ultimately have its day again, but specific to Wells Fargo, if the stock is such a good deal, famed value investor Warren Buffett — long a lover of bank equities and WFC stock — wouldn’t be pruning his stake in the California-based bank.
However, the Oracle of Omaha is doing just that. At the end of the third quarter, Berkshire Hathaway’s (NYSE:BRK.A, NYSE:BRK.B) $3 billion stake is a microscopic position considering the bank was once the conglomerate’s largest equity holding.
It’s just speculation, but one of the reasons Buffett is tiring of Wells Fargo could be the bank’s ethical lapses. A few years ago, there was the scandal of opening accounts on behalf of clients without their consent or knowledge. More recently, former CEO John Stumpf was hit with a $2.5 million fine by the Securities and Exchange Commission (SEC) for misleading investors.
Perhaps the most damning indictment of Wells Fargo vis-a-vis Buffett is that while Berkshire whittles down its position in that bank, it added to Bank of America (NYSE: BAC) in a big way in the September quarter.
Problems not Going Away Anytime Soon
Ethical missteps aside, the problems confounding Wells Fargo aren’t going to disappear overnight.
“We do not expect a straight line up for financial stocks, and caution that challenges remain, including still low interest rates and increased regulation,” wrote Frederick Cannon, director of research at Keefe, Bruyette & Woods, in a recent note.
Obviously, those are comments about the broader space and not specific to Wells Fargo. However, even if regulatory risk under the Biden Administration is less than expected for banks, there’s no getting around the specter of near-zero interest rates.
Then there’s the matter of dividends. Bank stocks are typically long-term investments. Dividend growth in the post-financial crisis added to that thesis. However, the pandemic prompted the Fed to tell domestic banks to hold off on growing payouts and buying back shares this year.
That’s bad enough, but then Wells Fargo went a step further and cut its dividend. With little vision as to when the bank can boost its payout, WFC stock yields 1.60%, paltry compared to the 3.57% on the KBW Nasdaq Bank Index.
So for investors who want to position for bank stocks resurgence, there are higher quality names out there beyond Wells Fargo.
On the date of publication, Todd Shriber did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Todd Shriber has been an InvestorPlace contributor since 2014.
