Bank stocks have experienced a significant rally, and to continue this upward momentum, lenders must prove that the market’s optimism is justified.
Strong Performance and Favorable Acquisitions
The SPDR S&P Bank exchange-traded fund has surged approximately 55% from its yearly low of around $31 in May to around $48 currently. Initially, this growth was driven by expectations that larger banks would benefit from the chaos in the regional banking sector. These expectations materialized through successful acquisitions, such as JPMorgan Chase’s purchase of First Republic. This move boosted earnings for JPMorgan Chase, as First Republic was operating profitably prior to concerns about solvency in the sector.
Lower Interest Rates Boost Prospects
Recent gains in bank stocks can be attributed to a drop in short-term interest rates. Investors anticipate that the Federal Reserve will respond to falling inflation by cutting interest rates. This decrease is expected to stimulate demand for goods and services, enabling banks to grant more loans.
Key Focus: Earnings Performance
However, the real test lies ahead. Investors are eagerly awaiting clear indications that banks are performing well in terms of earnings.
Analysts forecast modest revenue growth in 2024, as a result of various factors competing against each other. Profit per share of the ETF is expected to decline by just over 4% to $4.67 next year, while sales growth for the bank ETF is projected to reach 2.1%.
The logic behind these predictions is that although lower rates on long-dated loans may impede revenue growth, loan volume is likely to increase. While lending will become less profitable as interest rates decrease, staff remuneration is expected to rise slightly.
Despite these considerations, there is still room for bank stocks to continue their ascent. The potential for further decreases in short-term rates brightens the margin outlook, as banks rely on short-term borrowing to fund their loans. Additionally, a rise in demand for loans could further benefit banks.
Look Out for Management Confidence
Ultimately, the performance of bank stocks will greatly depend on management teams’ confidence in the outcomes discussed during their earnings reports. Positive sentiment during these discussions could further propel these stocks forward.
The Promising Outlook for Bank Stocks
The current market conditions present a unique opportunity for investors eyeing bank stocks. While still trading at affordable prices, bank ETFs are forecasted to have a price-to-earnings (P/E) ratio of approximately 9.9 over the next 12 months. This is significantly lower than the S&P 500’s P/E ratio of just over 19, indicating an attractive valuation within the sector. Furthermore, this lower valuation aligns with the historical range of discounts observed in the banking industry.
However, caution should be exercised due to the potential risk of disappointing net interest income and earnings if loan rates decline sharply and borrowing volume fails to increase substantially. An underappreciated possibility highlighted by UBS analyst Erika Najarian. Nevertheless, if lower interest rates do indeed contribute positively to banks’ profitability, these stocks could experience notable upside.
Looking at the banking landscape, investment banking may prove more appealing than consumer banking. Lorne Bycoff, co-founder of the Bycoff Group, suggests that institutions such as Goldman Sachs and Morgan Stanley, which have limited exposure to lending and instead focus on trading and mergers and acquisitions, may shine in this environment.
2023 is expected to witness a rebound in deal activity following a challenging year. With borrowing costs currently lower than average and continued growth projected for most businesses, mergers become increasingly enticing. Additionally, recovery in both stock and bond markets will bolster revenue from trading and wealth management for investment banks.
Goldman Sachs is predicted to achieve a 10% revenue increase to $50.8 billion next year, accompanied by an impressive 50% growth in earnings per share (EPS). Similarly, Morgan Stanley anticipates a 4% sales growth to $56.4 billion, with EPS potentially expanding by 18%, according to FactSet data.
If banks can deliver on these promising projections, their stocks have the potential to outperform within the sector.