Despite several attempts (including Operation Twist and the Maturity Extension Program) by the Federal Reserve Bank, the U.S. economy has yet to show any signs of respite. Unemployment continues to hover around 8%. The latest economic data on U.S. jobs was disappointing. Against an expectation of 130,000 new jobs, the economy created 96,000 jobs in the month of August. The average monthly job creation for the current year remained 139,000, against 153,000 in 2011. This shows a lack of momentum in the country's labor market. The central bank expects that unemployment will remain above 8% in 2012. GDP growth forecasts have also been trimmed from time to time. The bank expects the GDP will grow by no more than 2% this year.
Looking at the sluggish outlook for the economy, the Federal Reserve Bank announced another round of bond buying (QE3). The central bank will buy $40 billion a month and keep interest rates low until mid-2015. This time around, the Fed intends to buy Agency mortgage-backed securities (MBS) instead of Treasuries. By doing so, the bank will lower the yield on these MBS, which are linked to the 30-year government bond. As a result, the yield spread between the 30-year Treasury and MBS will narrow, enabling mortgagors to refinance their mortgages at lower rates.
As a result of the announcement, the S&P 500 advanced 6 points to 1,443, while the Dow Jones Industrial Average and NASDAQ Composite moved up 61 and 13 points to reach 13,394 and 3127, respectively. Besides the upward movement in commodities, financial stocks also gained ground. The Financial Select Sector SPDR (NYSEARCA:XLF) advanced 2.5%, while most of the large cap banks, including JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC), gained 3.7%, 3.6% and 4.8%, respectively.
The new round of easing will increase the reserves for banks and induce them to lend more. More lending will increase aggregate demand in the economy. The increase in aggregate demand will lead to a rise in spending, and as a result, a multiplier effect will occur.
Additionally, more lending will lead to higher revenues for these commercial banks. Among the large cap banks, Wells Fargo, US Bancorp (NYSE:USB) and JPMorgan have positioned themselves in a way that they will benefit the most from a post-QE3 scenario. We believe these banks are poised to benefit from the movements in the broad markets, as they have betas above 1. Therefore, we recommend that investors long these banks.
Wells Fargo (WFC)
With a beta of 1.3, Wells Fargo is up 29% YTD, and has the largest exposure to the U.S. housing sector among the rest of the large cap U.S. banks. The bank makes one out of every three mortgage originations in the U.S. The put call ratio for the stock is currently at 0.83 times, as compared to a one year high of 1.45 times. A total of 45.7 million shares of the bank are short, which is 0.9% of the free float. The short ratio of Wells Fargo's stock is 2.6 days.
In our earlier report (linked above), we saw JPMorgan, among the U.S. money-center banks, as having the second largest exposure to the U.S. housing sector. The bank originated approximately 12% of mortgages in the U.S. in the second quarter of 2012. JPMorgan's stock is up 26% since the beginning of the year, and has a beta of 1.31. Currently, JPMorgan's stock trades at a 14% discount to its book value. Compared to a one-year high of 1.54 times, the current put call ratio for JPMorgan is 1 times. Around 40 million shares of the bank are short, which is 1% of the free float. The short ratio of 2.1 days for JPMorgan is in proximity to that of Wells Fargo.
US Bancorp (USB)
US Bancorp's stock trades at a 100% premium to its book value, and has a beta of 0.99. The stock has seen 29% price appreciation since the beginning of the year. The bank is considered to have the third largest exposure to the U.S. housing sector. Approximately 21.6 million of the bank's shares are short, which is 1.1% of the entire free float. The bank has a short ratio of 3.3 days -- the highest among the three banks being considered. The put call ratio is currently 0.83 times, against the one-year high of 1.22 times.