Bank Of America: Buy The Dip, It Will Not Last

Mar.31.14 | About: Bank of (BAC)

Summary

Investors anticipating positive stress test results created a "buy the rumor sell the news" event.

Investors are potentially spooked by the flattening yield curve and geopolitical pressures.

These issues are transitory, creating a buying opportunity in the stock.

Bank of America's (NYSE:BAC) plan to increase the dividend to $0.05 per share and authorize a stock repurchase program of $4 billion was recently approved by the Fed.

This is great news for the company, yet the stock has subsequently sold off. In the following sections, I will propose why this has happened and why investors should see this as a buying opportunity.

Click to enlarge

(Chart provided by Finviz.com)

Clearly a "buy the rumor, sell the news" event

The "buy the rumor, sell the news" phenomenon occurs all the time in the markets today. Investors buy up stocks based on what they believe will happen in a given earnings report, economic event or new product release (the rumor). After the event transpires or the report is released (the news), they dump their positions and the stock moves lower. These buy the rumor sell the news spectacles often apply to things like the results of bank stress tests being announced. It seems Bank of America may be experiencing this effect as we speak.

Click to enlarge

(Chart provided by CNBC.com)

What happens is the stock rallies hard into the news. The rally occurs because investors are emboldened by the rumors their favorite stock - Bank of America, in this case -- is going to hit the ball out of the park in regard to exceeding the stress test requirements. The buying prior to the stress test results announcement runs the stock up significantly, leaving it vulnerable to profit-taking once the actual results are reported.

I posit this was clearly a buy the rumor sell the news event. Many investors, me included, were caught up in the whirlwind of speculation that Bank of America would pass the stress tests with flying colors. Eager investors pushed the stock up nearly 10% year-to-date, while the rest of the market languished. Often, this is the case with news results that are fairly well-telegraphed.

With the bank passing the stress test last year and management laser focused on cutting costs and improving margins, many new investors were drawn into the stock hoping for a quick pop to sell. This is exactly what happened.

Investors potentially spooked by mounting pressures

Yield curve at its flattest point since 2009

The yield curve denotes to the variance amongst short-term and long-term interest rates. Usually, short-term rates are lower than the long-term rates. As short-term rates rise and long-term rate lower or stay the same, the spread begins to narrow. Currently, the yield curve is at its flattest since 2009. If the process continues, short-term rates may eventually rise above long-term rates, creating an inverted yield curve.

An inverted yield curve is considered by a majority of market participants to be a precursor to a potential recession. The recent changes in interest rates have caused the yield curve to be at its flattest since 2009. I posit this will be a transitory event bought on by recent geopolitical concerns that will soon dissipate.

Macro-economic & Geopolitical Pressures

The recent flare-up of cold war tensions between the US and Russia has placed many investors on edge. The possibility of further, more biting sanctions being placed on Russia by the US and EU would not be good news for the global recovery. Further, the repercussions that may arise from the Russian response to the sanctions could drive down the stock process on major multinational companies with operations in Europe and Russia. Not to mention if Russia decides to invade Ukraine outright.

The issue is, I posit these issues will quickly dissipate. Russia has annexed Crimea and secured their warm water sea port. They are not interested in starting a war with the West.

The Fed's bearish comments

A major sell-off occurred when Janet Yellen suggested that the Fed could begin tightening interested rates within the next six months. On Monday, the 31st, Yellen gave another speech at the Chicago community reinvestment conference, where she seemed much more dovish than her earlier statements.

(Image provided by Pedro da Costa of WSJ)

I posit she was caught off-guard at the earlier news conference, and used this occasion to set the record straight. Yellen stated,

"There is considerable slack in the economy and labor market. The QE taper does not mean reduced stimulus commitment. The Fed is short of reaching its inflation and employment goals."

After the speech, the stock market took off like a rocket. This is good news for Bank of America. This could be the first step that may lead to a steepening of the yield curve.

Click to enlarge

(Chart provided by CNBC.com)

Conclusion

When you invest in a stock, you need to see the forest through the trees. Bank of America has pulled back after beating the stress tests for two main reasons. First, market participants ran the price up into the event causing a "sell the news" effect on the stock. Second, investors have become wary of stepping into banking names due to the flattening of the yield curve. On top of these two major issues, the geopolitical climate is extremely tense and uncertain currently. The good news is the market has been climbing this wall of worry quite well for the last five years, and I don't see why it won't do it again. I say you should ignore the noise and focus on the fundamentals of a stock. Bank of America's fundamentals are good and improving. Further, the bank is still undervalued on a historical basis. Buy the dip in Bank of America, it will not last.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.