To strengthen the U.S. economic recovery, the Federal Reserve Bank has announced the launch of its third round of easing (QE3). In this latest round, the central bank expects to purchase $40 billion worth of U.S. mortgage-backed securities every month. It also expects to keep policy rates at record lows until mid-2015, instead of the previous target of 2014.
All these measures will help strengthen the U.S. economic recovery. U.S. housing markets, which have bottomed, are already providing signs of improvements. Homebuilders ETF (XHB) is up 51% since the beginning of the year. Also, the Money Center Banks Index (BKX) and the broad Financial Select Sector ETF (XLF) are up 31% and 25%, respectively, on a YTD basis. This clearly reflects that the financial sector in the U.S. has underperformed the other high beta sectors. Besides underperforming, the sector is also under-owned. This is reflected in the percentage decline of the financial sector in the S&P 500 index. The graph below shows a drop from 21.5%, to as low as 8.57%, in the S&P in March 2009, just when the broad market was making its recent low. This was the lowest level since 1990. As the markets recovered, so did the percentage of the financial sector in the S&P 500. Currently, financials hold 14.4% of the broad market index. Therefore, the best way to play the possible U.S. economic recovery is through large-cap U.S. banks. Today, we aim to look at the banks that are under-owned, and that will benefit the most on the U.S. economic recovery, given their current attractive valuations.
The bank has a beta of 2.59, which means that an improvement in the broad market will have a greater impact on the bank's share price. The bank's extensive global footprint will help it grow. Approximately, 64.5 million shares of the bank are currently short, which is 2.2% of the free float. The short interest ratio for the stock is 2.2 days. The current put call ratio of 0.74 times decreased from over 0.96 times at the end of July this year. The decrease in the call ratio demonstrates the general bullish sentiment on the stock.
Citigroup is also considered to have the largest exposure to debt-stricken Europe. Any tentative improvement in the situation in Europe, due to the German court s decision to clear the way for a $643 billion emergency fund, will positively impact Citigroup.
Bank of America (BAC)
Bank of America has a beta of 2.31, with a large presence outside the U.S. Approximately 216 million shares or 2% of the free float is currently short, while the short ratio is 2 days. The number of short shares decreased from 231 million in the beginning of July this year. The put call ratio decreased from 0.69 times in the middle of August, to the current 0.56 times. The one-year high is 1.18 times. This trend shows favorable expectations among investors.
According to a market insight by ING Investments, the bank has the second largest exposure to the troubled nations of Europe (GIIPS), behind JPMorgan Chase (JPM). Around 8% of the bank's equity is exposed to the European GIIPS nations as compared to 10% for JPM. An improvement in the situation in Europe, in the aftermath of the German court's decision, will help appreciate the bank's share price.
Citigroup and Bank of America trade at attractive valuations with regards to their book values. C trades at a discount of 44% to its book value, against a 40% premium for Wells Fargo (WFC). Compared to this, BAC trades at a discount of 53% to its book value.
Citigroup and Bank of America, for the past 5 years, have on average been trading at book value multiples of 0.7 times and 0.69 times, respectively. The current P/B values of both banks are 0.56 times and 0.47 times.
Fifth Third Bancorp (FITB)
Fifth Third Bancorp, a regional bank in the U.S. financial sector, presented a stronger than expected performance in the second quarter of the current year. The bank has a high correlation to the movements in the broad market index. The stock has a beta of 2.14, while 35.3 million shares are short (3.9% of the free float). The short ratio is 3.7 days, while the current put call ratio for the bank is 0.87 times against the one-year high of 1.3 times in August this year.
FITB trades at a premium of 8% to its book value. Compared to this, the stock traded at 1.5 times its book value at the beginning of 2008.