Incoming President Donald Trump could not be more bullish for bank stocks, which have trailed the broader market for years. Trump could roll back banking regulation, or simply pay less attention to the banks — a change from the scrutiny they’ve received from the Biden Administration. Bank mergers and acquisitions will likely get approved faster, and a Trump presidency and lower interest rates could usher in more deal-making and initial public offering activity, boosting investment banking revenues.
The two largest banks in the U.S., JPMorgan Chase(NYSE: JPM) and Bank of America(NYSE: BAC), have already seen their stocks surge roughly 8% and 10%, respectively, since election day. It may not seem like much compared to some of the artificial intelligence high-flyers in today’s market, but it’s a big move for highly liquid, blue chip stocks with modest volatility. After the big move, Wall Street sees limited upside for one of these stocks, but rates the other as a strong buy.
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With roughly $4.2 trillion in assets, JPMorgan Chase is the largest bank in the U.S. The stock has flown roughly 40% this year, which again is a huge move for a stock with a beta roughly in line with the broader market.
Although several banks failed in 2023 due to poor balance sheet management amid the high-interest-rate environment, JPMorgan Chase has benefited. Corporate treasurers and CFOs who didn’t want to have their business at a bank that could fail flocked to large banks like JPMorgan that are too big to fail. Furthermore, the banking crisis enabled JPMorgan to acquire First Republic in an FDIC-assisted deal.
While First Republic would have likely failed had it not been acquired, JPMorgan Chase got a bank with a strong high-net-worth client base. JPMorgan Chase would not have been allowed to do the deal under normal circumstances, because it already has more than 10% of U.S. deposit market share and therefore cannot purchase any more U.S. banks by law. The deal also came with loss-sharing agreements with the FDIC.
Lower interest rates, a friendlier administration, and a steepening of the yield curve should benefit JPMorgan Chase. However, analysts believe the market has already factored these tailwinds into the stock price. Over the last three months, 19 analysts have issued reports on JPMorgan Chase, with 13 rating the stock a buy, five saying to hold the stock, and one saying to sell. The average consensus price target of roughly $234 implies roughly 3% downside.
Analysts’ caution is more about valuation than the actual business. JPMorgan Chase trades at more than 2.6x tangible book value or a bank’s net worth. This is nearly the highest valuation that JPMorgan Chase has had post-Great Recession. CEO Jamie Dimon is a great leader and the company is undoubtedly a best-in-breed bank stock, but the valuation is now stretched.
Long-term investors can still hold the stock without too much concern, given the quality of the business. More active investors may want to take profits and wait for a pullback. I recommend the active strategy more for retirement portfolios with fewer tax consequences.
It’s interesting. Bank of America and JPMorgan Chase trade on the same fundamentals, and analysts’ consensus price target for Bank of America only implies a little upside. However, analysts still view Bank of America as a strong buy. Wall Street brokers have issued 16 reports over the last three months, with 14 saying to buy and two saying to hold.
So what gives? According to Citigroup analyst Keith Horowitz, Bank of America could soon have a similar valuation to JPMorgan Chase, which has effectively set the market for the largest bank stocks. Currently, JPMorgan Chase has a cost of equity (COE) of 8.7% versus Bank of America at 10.2%.
COE represents the required risk premium to invest in a stock. In other words, investors expect Bank of America to generate 10.2% on their equity if they are to invest. Of course, this is more of a technical exercise, but it’s big in determining valuation. Horowitz expects the valuations to converge and for a “lighter regulatory environment” to potentially drive Bank of America’s returns above Citi’s 15% normalized assumption.
Bank of America’s balance sheet issues have been an overhang on the stock. Bank of America bought too many long-term, low-yielding bonds before interest rates soared. Those bonds fell deeply underwater, resulting in paper losses that hurt Bank of America’s tangible book value. Management then added swaps and other derivatives, which mitigated further interest rate risk but cost the bank revenue. As rates fall and with each passing quarter, the paper losses will decline and the swaps will mature, increasing Bank of America’s tangible book value and boosting profits.
Bank of America now trades at 1.75x tangible book value (as of Nov. 11). Long-term investors can continue to hold the stock. Bank of America and JPMorgan Chase are “set it and forget it” stocks that should serve investors well in the long run. For more active investors, I recommend trimming or selling Bank of America once it hits 2x tangible book value, which would be when the stock hits $52.50. It all depends on your trading style.
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Citigroup is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. JPMorgan Chase is an advertising partner of Motley Fool Money. Bram Berkowitz has positions in Bank of America and Citigroup. The Motley Fool has positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.
