This morning’s quarterly numbers from three of the largest U.S. financial institutions weren’t greeted with cheers. But if you think the banks are crashing, you just haven’t been paying attention.
The S&P 500 has made only minimal progress year to date (YTD). On average, the seven biggest bank stocks on my screen — including this morning’s “disappointments” — are up 5% over the same period of time.
In a world where the broad market normally needs six months to achieve a 5% return, that level of outperformance is as far from a sell signal as it gets.
As far as I’m concerned, the financial sector will lead Wall Street in the coming year. And the biggest banks, far from being a drag, will be right there doing most of the heavy lifting.
Consensus Versus Context
Citigroup Inc. (NYSE:C), Wells Fargo & Co. (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM) all lost ground this morning, but their numbers weren’t horrible at all, especially when you acknowledge that they’re still fighting a post-pandemic recession.
When the Fed cut interest rates to zero last year, the immediate goal was to protect credit markets as the economy cooled. However, while we were spared any 2008-style disasters, it’s hard for lenders to make money in this environment.
That’s why financial stocks as a group lost 4% last year, lagging the broad market by a staggering 20 percentage points. And it is why cash flow across the sector remains depressed.
Citi, for example, said this morning that revenue dropped 10% from 2019 levels in the recent quarter. Wall Street was steeled to see slightly worse deterioration, so that wasn’t a surprise at all.
But don’t blame the stock’s slide on either the historical numbers or “guidance.” Everyone still thinks revenue will remain sluggish for all the big banks until interest rates recover.
Meanwhile, profitability looks great when compared to last year’s miserable performance. If the company hits its marks in the current quarter, we’re looking for 70% year-over-year earnings growth.
That’s extremely rare in the relatively slow world of banking. And in a market that is still struggling to recover its pre-pandemic growth trend, it’s going to be huge.
We often say that any stock priced at an earnings multiple lower than its growth rate is a buy. Citi is on track to expand its earnings 26% in the coming year, and it’s still available at a lowly 11X multiple.
Likewise, JPM and WFC aren’t disappointments at all. The sky is not falling. Costs are up and revenue is down. We knew all this already.
The real fun starts when the pre-pandemic numbers roll out of the year-over-year comparisons in three months.
So why are the stocks down today? Take another look. They didn’t crash. They’re only giving back a little of their YTD gains.
This morning’s retreat winds the big banks back to levels they haven’t seen since Jan. 5. They’re now trading at a 10-day low.
That doesn’t feel like disaster to me. And with the rest of the sector looking for at least 20% earnings expansion this year followed by a return to normal interest rates in 2022 or 2023, better things are ahead.
After all, these stocks are still deeply depressed relative to where they were in 2019. Citi dropped 22% last year. JPM, the biggest and most defensive of the consumer banks, lost nearly 9%. WFC fell a harrowing 43%.
The banks haven’t gotten out of control. They’re simply recovering. As we learned in 2009, the recovery can be a once-in-a-generation buying opportunity.
How do we play it? Start by thinking like Warren Buffett. Lock in dividend yields while the stocks are still cheap.
That’s where my Value Authority shines. Every three months, the portfolio as a whole pays back 2-3% in cash, no matter what the market does.
We love the banks there. But there are other themes that have done even better for us.
Only subscribers know their names.