A crucial economic indicator, the M2 money supply, has shifted into expansion mode, alleviating investor concerns about the Federal Reserve's (Fed) hesitancy to cut interest rates by the end of 2024. This shift from a steady contraction to expansion is promising for those with buying power.
The U.S. money supply has seen a slight increase year over year. This modest growth is significant because it indicates the Fed is likely printing money in anticipation of cutting interest rates, a component of the 'quantitative easing' strategy to stimulate the economy.
Financial stocks like Bank of America Co. BAC. J.P. Morgan Chase & Co. JPM and Wells Fargo & Co. WFC are prime candidates for investors looking to capitalize on the Fed's new direction. As the newly injected currency is expected to reach consumers, these banks are set to see substantial benefits from the ensuing economic activity.
Why a Commercial Arm Drives Upside in These Banking Stocks
Newly injected capital into the system will make its way into the banks, whether more flexible reserves or customer deposits. Either way, having a more flexible financial position will translate into net interest income (NII) for these stocks, one of the industry's many key performance indicators (KPIs).
Speaking of interest income, Bank of America’s mortgage department took a 12% hit over the past 12 months, according to the company’s quarterly earnings presentation. Despite a slowing loans department, markets still felt comfortable bidding this stock to a new 52-week high recently in hopes of a turnaround.
Wells Fargo’s presentation shows that retail mortgage loan originations are down to their lowest level in the past year. Yet, the stock trades at 94% of its 52-week high price. J.P. Morgan’s mortgage department also saw a significant decline over the year, but the stock remains at 95% of its 52-week high.
How is the market justifying high prices in these financial stocks? Despite slowing fundamentals, that’s all in the rear-view mirror, and monetizing the future seems to be the most accessible call today. Multifamily home prices have declined by nearly 10% in the past year, driving some of the bullish sentiment.
As new liquidity hits the consumer and the banks, lower property prices may soon drive mortgage demand. More than that, U.S. home listings have unexpectedly jumped higher, maybe in expectations of the same trend.
The Dual Edge: How Investment Banking Activity Fuels Banking Profit Growth
More than just riding on consumer tailwinds, these banks have access to another path to further fuel their growth: the business's investment banking side.
With additional liquidity injected into the financial system, mergers and acquisitions (M&A) activity is set to grow as it historically has done each time the Fed raises the M2 money supply.
Apart from more buyouts and mergers entering the market with more flexible financing terms, more market liquidity tends to increase stock volatility, as evidenced by the peaks and troughs in the volatility index (VIX) across the M2 cycle.
Sales and trading will likely see increased commission revenue from this new activity, boosting shareholders' earnings per share (EPS). Adding to the potentially bullish thesis behind these stocks, other Wall Street analysts took notice and expressed their own opinions on the future valuations of these banks.
Understanding the Impact of Balance Sheet Revaluations on These Banking Stocks
As the Fed gets ready to lower interest rates in the coming months, one last side effect will help these banking stocks rise higher, and it all boils down to their balance sheets.
Most of these companies carry large amounts of bond securities in their balance sheets, and their values move opposite to interest rates. Because of this, if the Fed cuts rates in September, these bond values will boost the book value of Bank of America, Wells Fargo, and J.P. Morgan Chase stock.
That is why the UBS Group slapped a $224-a-share valuation on J.P. Morgan stock, daring it to rally 14% from today’s price. Oppenheimer set Bank of America’s stock price target to $46 a share, or 15.3% from today’s prices.
Last but not least, Evercore analysts saw it fit for Wells Fargo stock to value the bank at $67 a share. Apart from an annual dividend of 2.4%, this price target would represent an additional upside of 13.7% from where the stock trades today.
The article "Banking Stocks Eye Gains as Money Supply Rapidly Expands" first appeared on MarketBeat.
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