It’s been a roller coaster for the banking sector over the past few years. Under the Trump Administration, you had a huge corporate tax cut and several interest rate increases. This seemed to bode well for the banks in general, and Bank of America (NYSE:BAC) stock in particular.
However, the good times ended rather quickly. The Fed stopped its interest rate cycle in 2019, and the economy started to sputter a bit. Then Covid-19 hit and the bottom dropped out for the financials. Suddenly, bankers weren’t thinking about dividend increases or loan growth going forward, rather they were battening down the hatches for a retread of 2008.
Thankfully, this didn’t happen. The government reacted quickly with huge stimulus programs that helped keep consumers and small businesses afloat. Meanwhile, the banks entered the Covid-19 crisis in far better shape than they had in 2008. This time around, there was no housing bubble. On top of that, banks had to hold far more capital on their balance sheets thanks to regulatory changes made following the previous bust.
Quickly Recovering From Covid-19
As such, banks went into 2020 with a ton of reserves ready to meet any storm, and they hadn’t lent aggressively against homes of dubious value. Add it all up and by early this year, it was clear that banks would not suffer much in the way of meaningful credit losses as a result. Sure, the odd bank here and there took a bath on iffy loans to more speculative ventures such as restaurants, malls, or construction loans. By and large, however, banks sailed through the bust.
BAC stock, along with most other too-big-to-fail peers, has recovered its stock price losses from the Covid-19 panic. However, investors are underselling the recovery. Not only have the banks shook off last year’s trouble, they’re actually in far better shape than they were pre-Covid. Here’s why.
A Better Outlook In This Accelerating Economy
The first key change is that banks are now enjoying a far more favorable interest rate environment. The Federal Reserve hasn’t officially tightened interest rates yet. However, they’ve hinted that they’re starting to think about a move. Already, the market is pricing in a significant move in the yields on U.S. government treasury bonds. Those, in turn, tend to set the rates that banks can charge on mortgages. As those pop, Bank of America can earn more from its lending program.
Second, there’s a wave of inflation about. Inflation can be good or bad for banks, depending on the form it comes in. This, however, looks like “good” inflation for the sector. Consumers are rushing out to buy homes, cars, appliances, vacations, and other big-ticket items. They’re moving so quickly, in fact, that it’s causing shortages of many key inputs. We’ve seen shortages in things ranging from lumber and copper to semiconductor chips as companies struggle to keep up with all the buying.
How This Filters Into BAC Stock Earnings
This is great for banks with consumer credit, since much of that spending ends up being with borrowed funds. Additionally, companies are racing to up their output, which in turn requires investment in capital goods, along with paying employees higher wages. These investments and wage increases, in turn, end up funding more consumption and GDP growth, which drives more activity at the bank. This is a textbook virtuous cycle.
As if that weren’t enough, Bank of America isn’t just retail business, either. It has a large investment bank which does capital market activities such as underwriting initial public offerings (IPOs) and bond offerings along with advising to companies pursuing mergers and acquisitions (M&A). As you can guess, with the stock market flying higher, it is generating all sorts of demand for stock and bond market expertise from the major investment banks such as Bank of America.
BAC Stock Verdict
There’s no need to make this too complicated. Bank of America and the banking sector are firing on all cylinders. The housing market is through the roof, which is great for banks on multiple fronts. Interest rates are trending higher, this week’s dip notwithstanding, in a favorable manner for the banking sector. And regulatory concerns are fading; the Federal Reserve is loosening up restrictions once again now that it’s clear the banking sector sailed through Covid-19 without facing major losses.
All this is set to pave the way for BAC stock to continue plowing much higher. The only real question is which big bank to own. My top pick in the sector is Goldman Sachs (NYSE:GS), as its management is incredibly good at running a tight ship. But, regardless of whether you hold Goldman, JP Morgan (NYSE:JPM), Bank of America or some other such rival, there’s a good chance its share price is going a lot higher over the next 12 months.
Many traders see that the bank stocks have moved up a lot and turn their thoughts to profit-taking. That’s a perfectly understandable reaction in the short-term. Farther out, however, it seems clear that the banking rally is still in the early innings. Investors selling BAC stock here are likely to miss out on at least another year of sizzling earnings for the company going forward.
On the date of publication, Ian Bezek held a long position in GS stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.