- Poor US jobs number, announced last week, will ensure that the Fed won't raise interest rates which is bearish for Bank of America stock.
- The S&P-500 is coming up against major resistance. I see much lower prices ahead for the next 8 to 10 weeks.
- The bank's low price to book ratio doesn't necessarily indicate value but rather low profitability.
Bank of America (NYSE:BAC) stock is down almost 3% (now trading at around $14.35) since the poor US jobs numbers were reported last Friday. In fact, the stock almost went down a full $1 after the announcement which illustrated again how this financial company is far more sensitive to changes in interest rate policy compared to the general financial ETF Financial Select Sector SPDR ETF (NYSEMKT:XLF) for example. One of the metrics I watch closely in the financial sector is the respective company's return on equity which came in at 3.8% last quarter for Bank of America, which was a full 1.1% lower than the quarter of 12 months prior.
Even if we take restructuring into account, the bank's ROE still didn't even surpass 8% which is worrying from an investors standpoint. Why? Well if the Fed stands pat on its interest rate policy, the bank will have to keep cutting costs and capex to improve its profitability which could become a hindrance over the long term. Why? Well, other banks may be able to take advantage of market conditions when rates really do rise meaningfully because of less deep cuts than the likes of Bank of America has been doing.
Bank Of America Too Sensitive To Interest Rates
Bank Of America's current CEO Brian Moynihan stated recently in an interview that a 100 basis point change in interest rates would result in an extra $6 billion being added to its net interest income metric. A hike by the Fed would do wonders for the bank's return on assets metric which again came in at a poor 0.5% in the first quarter. This is the problem a large loan portfolio of $900 billion+ (net interest income makes up almost 50% of its total income) creates for a bank in a low interest rate environment. This is why this bank is extremely sensitive to the health of the US economy. If one is long the US, then being long Bank of America makes sense. However, I just can't see margins and subsequently earnings improve (see below) until interest rates rise meaningfully.
Equity Markets Due To Decline At Any Time Now
The second reason why I don't like Bank of America at present is because I feel the S&P-500 is setting up for a hard top here and if economic numbers continue to deteriorate in the US, then banks could easily lead the decline into an intermediate low. Since the S&P-500 bottomed in mid February, banks have been leading the charge and BAC has actually outperformed the financial ETF (NYSE:XLF) and the S&P-500 (see chart) but i think that is all going to change.
Why? Well, remember that the Fed's initial projection was to raise interest rates 4 times in 2016 but now I believe it will be lucky to do it even once. Furthermore, the S&P500 took out its November highs yesterday and now I believe its only a matter of time before the index tests its all time high. However, I can't see the S&P500 breaking through its all time highs on its first attempt. Moreover, the stock market is due an intermediate decline at this point as we are 17 weeks into this intermediate cycle. Normally these cycles last 22 to 25 weeks so a gradual correction of 5 to 7 weeks looks probable to me at this stage and the leveraged nature of financials means this sector could easily lead the market down into an intermediate low over the near term.
Low Book Value Per Share Because Of Low Profitability
Therefore, I would caution investors who are sizing up Bank Of America as a strong value play at these levels. Yes, everything on the surface stacks up. Bank Of America 's present book value per share is $23.21 and although net interest margins continue to decline, the bank still brought in $15.47 billion in net income last year. However, I believe the risk is very much to the downside with this stock as its present price to book ratio of 0.64 reflects the poor profitability it is currently achieving compared to the likes of Wells Fargo (NYSE:WFC) in this space. Caution is definitely warranted at present.
To sum up, now that an interest rate hike is firmly off the table for June, I believe Bank of America at very best will trade in a range for the rest of the year. The bank is over-sensitive to interest rate movement due to its large loan book which is stifling its profitability. Furthermore, its profitability is nowhere near the likes of Wells Fargo ( Which has trailing ROE & ROA averages of 12.4% and 1.18% currently) which is why I still believe its a speculative investment at best here. Moreover, watch the S&P500 as it is due a correction at any time which would undoubtedly apply pressure on Bank Of America stock.