Bank stocks bounce hard

Financial stocks were the one of the hottest areas in late 2015, and most advisers believed the trend would carry well into the new year. So what went wrong this year?

Financial stocks were the one of the hottest areas in late 2015, and most advisers believed the trend would carry well into the new year.

Advisers were told that the economy would boom in 2016 on top of raising interest rates, a double whammy which would translate into more loans and higher returns from those loans.

So what went wrong?

Everything, apparently. “It all disappeared quickly,” says David Ellison, portfolio manager of Hennessy Large Cap Financial Fund (HLFNX).

The Fed did indeed raise interest rates, but the stock market swooned on worries about the economy. And while the Standard and Poor’s 500 stock index has fallen 6.12% this year as of Thursday, including reinvested interest, financial services stocks have tumbled 11.4%, according to Morningstar.

Is this time to go bargain-hunting?
Bank of America, for example, is down 16% this year; JPMorgan Chase is down 9.2%. Bank of America is selling below book value; JPMorgan Chase is just barely above book.

Mr. Ellison feels more like it’s time to hunker down. “The issue to me is that the industry is struggling with revenue problems,” he said. Part of that is the spread between what they pay for deposits and what they charge on loans, which remains narrow.

Another part is simply the low level of rates. The average 30-year mortgage rate is 3.72%, according to Freddie Mac. “You can’t make a 30-year mortgage or a 15-year loan and have confidence that the asset will hold up,” Mr. Ellison said. Or, for that matter, that rates won’t rise and hurt the value of your loan.

Those who bet on an improving U.S. economy could be right: It’s the best-looking house in a shaky neighborhood, he said. But the economy is far more global than it was in 2008, and weak economies in Europe, China and Japan will weigh heavily on U.S. interest rates.

“It’s like saying things in Boston are good, but things in Houston are bad, so on balance, it’s neutral,” Mr. Ellison said.

Bank stocks are certainly cheap on traditional metrics, such as price to earnings and price to book. Until banks can figure out ways to grow earnings, however, Mr. Ellison is hunkering down and waiting for clearer direction.

“I’m basically owning the companies where management is paying attention,” he said. “They have capital, good returns, and understand what’s happening.” Among his holdings: Wells Fargo, Bank of America, JPMorgan Chase, SunTrust, M&T.

“The issue I keep coming back to is that big banks have to lend,” Mr. Ellison said. Just how they do so with any confidence, given world central banks and the global economy, is the big question, he added.