"The past few years have shown that bank stocks gain over 10 percent in 1Q only to lose 9 percent in 2Q when out-year estimates start to decline," Goldman said. "With 1Q earnings likely to be weak, we see the risk that history repeats itself with the start of another negative (earnings) revision cycle."
The bank cites the three following factors in its decision to warn investors about a possible nine percent drop in the second quarter for bank stocks overall. First, loan growth contracted two percent in the first quarter after expanding three percent in the prior quarter. Second, slower activity in the capital markets including a drop off in IPOs and M&A activity. Finally, third on Goldman's list is declining confidence in the economy.
Maybe Goldman has been living under a gigantic, gold-plated rock somewhere in Manhattan for the past year or so but does anyone consider this new information? Seriously, everyone and their brother knows that loan activity is declining due to a number of reasons such as reduced HARP activity and seasonal effects on the housing market, among others. Last year saw an enormous refinancing boom and new and existing home sales that have finally come out of the trough so of course loan activity is slowing a bit relative to last year.
Goldman then cites that M&A activity was more than double 2012's first quarter level, as measured by dollar amount. I understand that the number of deals was down but still, how bad can it be if last year's number was more than doubled?
Finally, Goldman lists declining confidence in the economy as a reason that bank stocks will decline. Pardon me for having no clue what consumer confidence has to do with bank stock valuations but let's assume that Goldman is on to something here. Even if consumer confidence does continue to decline, as it actually is lower from February of this year, in looking at a long-term chart, when did it ever rise to a "confident" level in the first place?
Chart is courtesy the Federal Reserve Bank of St. Louis
Certainly, things are better since the throes of the financial crisis but if we look at the end of this chart, we can see that consumer sentiment just plain stinks, as it has since 2006. Again, this is not new information Goldman is citing here.
Given all of that, Goldman's premise is that just because bank stocks have rallied more than 10% in the first quarter, there is some magical rule that they must give back those gains in the second quarter. While this makes no sense by itself, even if it were true, why are they so sure it will happen again? I understand the indices are at all-time highs and that caution is probably warranted in the very near term but banks falling 10% in the second quarter seems a bit harsh given that no new significant information is available now that wasn't available last week or last month for that matter. To be honest, I'm disappointed that Goldman let such an elementary and pointless note come out of the bank.
As investors, what can we do with this "information" Goldman has provided to us? The main takeaway here is that if people believe what Goldman is saying and decide to take down bank stocks, we should all consider it a wonderful gift provided to us by Mr. Market and his irrational participants. If you want to take advantage of the dire circumstances in the loan market that Goldman cites, you could do worse than to pick up cheap shares of Wells Fargo (WFC) or Bank of America (BAC) as leveraged plays on an improving housing market. I prefer BAC due to its much cheaper valuation and leverage with its Countrywide unit. BAC has a price to book value of about 0.60 while WFC is more than double that at 1.35. WFC trades at a premium due to the rock solid, profitable franchise it enjoys but you get a rapidly improving play on the housing market with BAC. In addition, WFC is already the undisputed market leader in residential mortgages so the larger gains have likely been seen already.
If you want to play the M&A activity that Goldman mentions, you can add shares of Morgan Stanley (MS), JPMorgan (JPM) or the old girl herself, Goldman Sachs , as plays on increased M&A activity. My favorite of this bunch is JPM for its unyielding leadership position in the banking industry and relatively cheap valuation. Beware the "Dimon Premium" in this name however; if certain shareholders get their way and strip the best CEO in banking of his Chairmanship, some of that beloved premium may evaporate into the Manhattan air.
The bottom line for me is that the best way to play Goldman's note is to wait and see. Selling because some random, unnamed Goldman Sachs employees said that bank stocks will magically fall in the second quarter because they are supposed to is foolhardy at best and downright stupid at worst. Perhaps, by some miracle, Goldman will be proven correct on its assertion that bank stocks are currently overvalued by 10% but that is not a bet I'm willing to make. The Fed has decided to print money indefinitely and as such, any risk asset is a good place to be. This is particularly true with banks as the environment we are currently in is a perfect storm for bank profits.
The best stock to take advantage of all of these factors, if you want just one, is Bank of America. BAC has its tentacles in M&A and IPOs with its Merrill Lynch unit and is my overwhelming favorite play on the housing market with its Countrywide unit. BAC has endured many, many lawsuits and billions of dollars in losses due to its Countrywide unit but the tides are turning and BAC will reap the profits from the booming housing market in the years to come. BAC is still languishing in the financial crisis with a return on assets of 0.19%, dwarfed by WFC's 1.42%, for instance. However, WFC shareholders pay a premium for that outperformance and once BAC reaches 1% ROA and beyond, the easy money will have been made. Bank of America is still being valued like it has just barely moved out of the financial crisis, being left in the proverbial dust by its competitors. However, we have seen that CEO Moynihan has righted the ship and the future is brighter than BAC's valuation would suggest.
So please, do yourself a favor and ignore what Goldman said about bank stocks in the second quarter. This note is nothing but recycled, repackaged information that does nothing but attempt to instill fear and selling into the investing public. If bank stocks decline 10% in the second quarter, it will be for a good reason and not just because "it has happened before" as Goldman states. Bank stocks are a good buy at current levels and if they decline 10% in the next two months, they will be great buys. Put your list together now in case the selloff occurs and one more thing; make sure BAC is at the top of that list.