When it comes to track records, I can't think of anyone that has dropped the ball more than the bank equity analysts this year. As the market continues to look more and more dismal upon signs of a global economic contraction and the rapid devaluation of the Euro, the fact that analysts are bullish on every single one of the major banks reminds me a whole lot of 2008 where rating agencies and analysts were completely confident on the "ticking time-bomb" mortgage-backed securities despite severe flaws in their fundamental components.
Take Bank of America (NYSE:BAC) for instance, which analysts have been bullish on the entire year. Three months ago, the markets were relatively calm as the focus was on earnings, and the aftermath of the commodity crash in May. The price of BAC shares slid near $10/share from the $14/share highs in the beginning of the year at this time, but analysts held their ground and even kept similar price targets on the stock. Below is a recent history of analyst recommendations for BAC shares.
Why were so many analysts so confident that the risk to reward ratio of BAC was so favorable? It's insane that only one of these analysts thought that maybe the shares were a value trap given that BAC is still bleeding money from litigation costs from mortgage transactions in 2009 and earlier. Then there was one other brave soul who dared to issue an "underweight" rating on the stock. If anything, the rating system should be reworded. In analyst speech, hold means sell and sell basically means go short.
In a desperate effort to cut costs further, Bank of America has recently issued a statement which described the bank's efforts to cut costs by 15%, which includes a reduction in headcount to the tune of 40,000. This reeks of desperation. In addition, there are all sorts of "surprises" that investors may still be encountering with BAC's balance sheet, like the 10 billion dollar loss to AIG which is sparking new lawsuits against the bank's fraudulent statements towards shareholders. This only makes the situation worse, without even accounting for the political implications. Any politician looking for easy votes can find a way to hurt the bank as much as possible. Bank of America's list of friends runs thin indeed.
There are many reasons that you can argue that the bank is cheap, but what we can infer so far is that the analysts were dead wrong all the way since January. To be fair, BAC analysts couldn't have foreseen things like the hidden $10 billion dollar loss to AIG but there are a huge list of problems that the bank still hasn't dealt with yet. This should prevent any significant bullishness. The fact that there are still 13 analysts with a buy rating on the stock says a lot too. If the bank loses this support, where will buyers come from? Are these analysts accountable in the slightest for their ratings?
On top of everything else, the eurozone is truly on the verge of collapsing. It's hard to tell how much longer the ECB can keep Greece alive and kicking, but it's only a matter of time before new leaders get elected who will take a stance against the feeble austerity measures that have been enough to pacify European leaders so far. While a Greek default in itself won't crush US banks by itself, the fallout from this event could easily knock over the likes of Bank of America.
BAC is a very large but feeble financial institution which is not even earning money, years after the housing bubble burst. There are probably "surprises" that we have yet to uncover, as the company's shares continue to descend further. In contrast; JPMorgan (NYSE:JPM) has been consistently beating analyst estimates on earnings and is even capable of paying a hefty dividend. Bank of America passed the stress tests given by the government in March, but was deemed too weak to pay out cash to shareholders. Is that really considered a pass?
Above are the analyst ratings of shares of Citigroup (NYSE:C) - Bank of America's TARP-twin. The overall problems are overlapping for the banking industry, and Citigroup shares have been hit about as hard as BAC shares. Their supposedly focused growth on commercial banking abroad has ended up a failure thus far, as the rapid slowdown in the global economy has proven to be a painful situation for commercial banks. As low as interest rates are, bad global economies will hit bank profits hard. Only one analyst out of twenty six was right about Citigroup this summer with the "Sell" rating. For the most part, analysts have not moved their ratings on this bank despite the impending debt meltdown which the ECB has been stalling for far too long. As stated, Citigroup won't have direct exposure to Greece but the fragility of our financial institutions at this time can't be understated.
Morgan Stanley (NYSE:MS) stock ratings are shown above. This was one of the worst (or "best") examples, as shares of MS have had a gut-wrenching 40% decline in the last 3 months. As you can see, not a single analyst had a sell rating on the stock. Only one person dared to put an "underweight" rating, and many analysts recommended that investors buy the stock. If you had listened, you would have lost 40% of the money you put in (or more if you were unfortunate enough to buy on margin). Even now, many analysts are recommending buying this stock as it trades at a P/E of 22.8, despite the ridiculous risks that could be coming from the eurozone crisis, a stronger dollar, and a global economic contraction.
S&P analysts have given exceptionally useless ratings on bank stocks this year. Their worst call was probably Bank of America (BAC), which had a neutral rating until the late summer where it was issued a "strong buy" rating the two months leading up to the August crash. It quickly reacted to the market crash by downgrading the stock to a neutral rating, only to bring it back up to a buy rating a few days later. Anyone following this advice would have been absolutely crushed. Next on the list is the 4-star "Buy" rating they've had on JPMorgan Chase (JPM) for the entire year (besides January where it was a "Strong Buy", adding even more pain to their track record). The same can be said for Citigroup (C), which has been a 4-star "Buy" the entire year, only to destroy investor capital for essentially the entire year. The only prediction that didn't technically lose investors any money was the 3-star "Hold" rating that's been on Wells Fargo (NYSE:WFC) the entire year, although you can argue that it did lose investors money by being completely blind to the incredibly prolonged decline in financial equities and not issuing any "sell" ratings.
Ultimately, what we can infer is that these rating agencies are behaving like they did in 2008. The overall confidence in the housing market flushed out any bears that tried to argue against the frailty of the situation. In a similar situation, analysts are afraid to downgrade financial stocks because of what others are thinking. Nobody wants to be the bear when everyone else is bullish, and it's this kind of social behavior that will get you slaughtered in the stock market. Unless the banks can churn out amazing profits in the near future, there's no reason to expect these stocks to rocket upwards. Analysts have already inflated the value of these stocks with their ridiculously high price targets. When you see estimates of $54.5/share (on average!) for JPM, or $35.5/share for WFC, you begin to wonder if you should be listening to these people. On a sidenote, these price targets were roughly the same last year. The shares have done the complete opposite of what these experts have predicted.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.