March 16, 2016

Bank Stocks appear to be cheap

Banks are probably among the cheapest stocks to buy right now -- especially if you don't share my global economic concerns, have a more optimistic view of world stock markets or are just looking for long "hedges."

The reasons I say that:

-    Global interest rates have likely bottomed, so net interest margins have probably troughed.

-    Fears of the Federal Reserve dropping U.S. interest rates into negative territory seem dramatically overdone.

-    Global gross domestic product should see a slow but gradual recovery, providing banks with a reasonable backdrop for profit gains as credit demand rises and compliance-and-regulatory expenses' drag moderates. As I've repeatedly written, banks have done a fine job of cutting overhead to offset the lost income from falling interest rates, a flattening yield curve and tepid capital-market activity.

-    U.S. credit-quality fears might be overstated. Importantly, I would note that the high-yield-credit market has begun to rebound and is seeing narrowing spreads relative to Treasuries.

-    CEO Jamie Dimon's recent decision to purchase 500,000 shares of JPMorgan Chase  (JPM) attracted the most attention, but other bank executives are also buying. (Check out Jim "El Capitan" Cramer's take on Dimon's move here.)

-    Any improvement in the market's sentiment towards bank stocks could result in a relatively pronounced move to higher valuations. Banks' price-to-earnings ratios have been muted for years despite markedly reduced leverage and the prospect of more-consistent future profits.

-    Bank valuations also arguably already discount a global recession, rising credit-quality concerns and the idea that lower interest rates will continue forever. As such, I believe bank-stock prices could rise even if firms only grow their 2016 profits modestly.

As for this week's European Central Bank moves, I believe investors can view the stimulus package that the ECB unveiled as a positive outcome relative to low expectations.

It's true that European loan demand remains weak, so ECB Chief Mario Draghi is "pushing on a string" to some degree. Moreover, European banks are also over-leveraged, as well as burdened by poor credit quality and overpriced sovereign debt.

But these facts were already known, so I think European bank stocks are better positioned today (albeit from low levels) because of the policy announcements.

Significantly, Draghi emphasized that negative interest rates might not be permanent, or at least that further rate cuts might not occur. Also remember that the ECB is now essentially paying banks to lend out money.

My advice: Let's keep an eye on Deutsche Bank (DB) as a proxy for eurozone financial institutions and a guidepost for where U.S. bank stocks could be heading.

In the meantime, to paraphrase Pat Benatar, Draghi has apparently "hit banks with his best shot," so it's likely time to "fire away" and buy. I currently have eight banks on my "Best Long Ideas" list.

That said, given my overall negative market view, I plan to short an equivalent amount of my favorite shorts any time that I buy more bank longs. That way, I won't alter my "all-in" net-short exposure.

Position: Long C, BAC, JPM, RF, BBT, FITB, WFC, SONA, CMA

via thestreet