It has been a roller coaster for the banking industry in recent years. Under the Trump administration, you had a huge corporate tax cut and several interest rate hikes. This seemed to bode well for banks in general, and Bank of America (NYSE:BAC) stock in particular.
However, the good times ended pretty quickly. The Fed halted its interest rate cycle in 2019, and the economy started to falter a bit. Then Covid-19 hit and the bottom dropped for finances. Suddenly, bankers were no longer thinking of increasing dividends or growing loans, but rather closing the hatches for a 2008 retread.
Fortunately, this did not happen. The government responded quickly with huge stimulus packages that helped keep consumers and small businesses afloat. Meanwhile, banks entered the Covid-19 crisis in much better shape than in 2008. This time around, there was no real estate bubble. On top of that, banks had to hold a lot more capital on their balance sheets thanks to regulatory changes made as a result of the previous crisis.
Recover quickly from Covid-19
As such, banks entered 2020 with a ton of reserves ready to weather any storm, and they hadn’t aggressively loaned against houses of dubious value. Add it all up and by the start of this year it was clear that the banks would not suffer many significant credit losses as a result. Of course, a few banks here and there have taken a dip in bad loans to more speculative businesses such as restaurants, malls or construction loans. Overall, however, the banks have come through the bust.
BAC stock, along with most other too-big-to-fail peers, has recouped its stock price losses from the Covid-19 panic. However, investors are underestimating the recovery. Not only have the banks gotten rid of the problems of the last year, they’re actually in much better shape than they were before Covid. Here’s why.
Better prospects in this accelerating economy
The first key change is that banks now benefit from a much more favorable interest rate environment. The Federal Reserve has yet to officially tighten interest rates. However, they hinted that they were starting to think about a move. Already, the market is anticipating a significant shift in yields on US Treasuries. These, in turn, tend to set the rates that banks can charge on mortgages. As these pop up, Bank of America may earn more from its loan program.
Second, there is a wave of inflation. Inflation can be good or bad for banks, depending on what form it takes. However, this appears to be “good” inflation for the sector. Consumers are rushing to buy homes, cars, appliances, vacations, and other big-ticket items. They move so quickly, in fact, that it causes shortages of many key inputs. We have seen shortages in areas ranging from lumber and copper to semiconductor chips as companies struggle to keep track of all purchases.
How it filters into the profits of BAC stocks
This is great for banks with consumer credit because a lot of that spending ends up being with borrowed funds. In addition, companies are rushing to increase production, which in turn requires investments in capital goods, as well as higher wages for employees. These investments and wage increases in turn end up financing more consumption and GDP growth, which in turn stimulates the bank’s activity. It is a classic virtuous circle.
As if that weren’t enough, Bank of America isn’t just a retail business. It has a large investment bank that engages in capital market activities such as underwriting initial public offerings (IPOs) and bond issues, as well as advising companies pursuing mergers and acquisitions ( MY). As you can guess, with the rise of the stock market, it generates all kinds of demands for expertise in the stock and bond markets from the big investment banks such as Bank of America.
Verdict Stock BAC
There is no need to make it too complicated. Bank of America and the banking industry are in full swing. The housing market is exploding, which is great for banks on several fronts. Interest rates are trending up, despite this week’s drop, in a favorable way for the banking sector. And regulatory concerns are fading; The Federal Reserve is easing restrictions again now that it is clear that the banking industry has gone through Covid-19 without incurring major losses.
All of this should pave the way for LAC’s stock to continue plowing much higher. The only real question is which big bank to own. My top pick in the industry is Goldman Sachs (NYSE:SG), because its handling is incredibly good at handling a tight ship. But whether or not you own Goldman, JP Morgan (NYSE:JPM), Bank of America, or some other such rival, there’s a good chance its stock price will go up a lot over the next 12 months.
Many traders see that bank stocks have risen a lot and look to profit taking. This is a perfectly understandable short-term reaction. Further down, however, it seems clear that the banking rally is still in its infancy. Investors who sell BAC shares here risk missing out at least another year of sizzling profits for the company in the future.
As of the publication date, Ian Bezek was long in GS stock. The opinions expressed in this article are those of the author, subject to the publication guidelines of InvestorPlace.com.
Ian Bezek has written over 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a junior analyst for Kerrisdale Capital, a $ 300 million New York-based hedge fund. You can reach him on Twitter at @irbezek.