Key points
- Lower interest rates typically help bank stocks, but not all stocks are created equal in this sector.
- Commercial banks have an advantage over investment banks in this cycle based on their balance sheets.
- Markets are willing to pay the price for two banking names, expecting higher prices.
- 5 stocks we like better than the iShares 20+ Year Treasury Bond ETF
Each cycle brings new opportunities; now that the Federal Reserve (the Fed) is looking to cut interest rates in 2024, the market may be preparing to move in a new direction. Banking stocks could be the first to move, as they are tied to the financial momentum of the economy.
However, not all bank stocks are created equal. There are investment banks and commercial banks. In this new rate cycle, the market is suggesting that the banking sector expects to outperform the rest of the financial sector. Supported by fundamentals, investors may take a closer look at the next wave.
Initially, hybrid (investment and commercial) banks like them. JP Morgan Chase & Co. New York Stock Exchange: JPM AND Northern Trust Co. NASDAQ:NTRS they are the type of institutions that the market seeks to buy, regardless of price. Overpaying for potential future returns is a trend in these stocks that starts here.
Why do banks offer lower rates?
Traders are betting that the Fed will cut interest rates by May or June 2024, a trend that investors can track through the FedWatch tool offered by the CME Group Inc. NASDAQ: ECM. Because markets move well before the trend becomes apparent, JP Morgan shares are now flirting with new all-time highs.
However, there is still a long way to go, which means investors could use further momentum. Northern Trust shares are trading above 52-week highs, but have yet to reclaim their 2022 high of $135 per share.
Northern offers a different opportunity for those looking for a buying opportunity on the dip of JP Morgan’s momentum. Northern Trust’s advantage comes from its $49 billion in debt securities, typically made up of government bonds such as 10-year Treasuries.
JP Morgan also has some of these assets on its balance sheet, but market enthusiasm may come from the bank’s exposure to investment banking. Lower interest rates typically trigger mergers and acquisitions (M&A) activity, which brings these banks a good chunk of fees and revenue.
Lower interest rates set by the Fed affect bond interest rates, and when rates fall, bond prices rise. Knowing this, investors may want to gain some exposure to banks like Northern Trust, whose assets primarily include bonds and loans. If Northern Trust’s book value were to rise (due to more valuable bonds), its share price could follow.
For JP Morgan, the thesis may be rooted in expectations of higher earnings per share (EPS) from its investment banking departments in the heating sector. In fact, analysts at Wells Fargo & Co. New York Stock Exchange: WFC they raised their price targets for the bank to $220 per share starting in March 2024, predicting an 11% upside from today’s prices.
The market voted
The financial sector, focused on the commercial banking sector, currently trades at a price-to-earnings (P/E) valuation of 9.8x. JP Morgan’s valuation today is 28% higher than the industry average, as the stock trades at 12.5 times.
Northern Trust shares are valued 43% above the industry standard at its P/E multiple of 14x. The market must have sufficient reason to pay a premium valuation for these names; knowing how rates can affect these stocks, retail investors now have an idea of what Wall Street is looking for.
By strengthening the momentum and downside opportunities of these stocks, investors can compare their performance over the past 12 months with that of the SPDR fund for selected financial sectors NYSEARCA: XLF. JP Morgan shares outperformed the sector by up to 23%.
In contrast, other banks such as Goldman Sachs, which are more focused on investment banking activities, have underperformed these hybrid stocks. Over the past 12 months, JP Morgan stock has lagged its competitor by 26.2%, showing investors how these fundamentals come into play.
Enough fuel to burn
With recent initial public offerings (IPOs) hot as Reddit Inc. NYSE: RDDT, investors can evaluate the underlying fuel in the economic context. M&A activity is also on the rise Home Depot Inc. New York Stock Exchange: HD it also made an $18 billion acquisition last week.
These stocks typically don’t come during stagnant economic times, so these banking names could be set to bounce back next quarter, fueled by economic momentum and hopes of lower interest rates.
Investors can follow price action in bond-based exchange traded funds (ETFs) like the iShares 20+ year Treasury bond ETF NASDAQ: TLT to keep up with the movement of bond yields and how those yields might affect bank stocks.
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