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BondBeast Posted1 4 years ago

Higher Rates and Higher Volatility While the Federal Reserve didn’t raise interest rates in its most recent meeting, this doesn’t mean more rate hikes aren’t coming. Whether it’s three total hikes this year or four doesn’t matter a whole lot. What does matter is the trend and when it comes to interest rates — and that’s higher. Banks are using these higher interest rates to earn more money on their customers’ deposits — without passing on much of a higher rate to them. In the end, the banks are getting a bump to their net interest margins, which is fancy talk for saying they are becoming more profitable. In this case, it’s happening without more risk. Second, higher volatility also bodes well for Bank of America. While that volatility may make it harder to own BAC stock, it does wonders for its trading-desk revenues. Trading revenue was a huge drag for the banks in 2017, thanks to the historically low volatility. 2018 is a different year and with the blowup of the short-volatility/long-equities trade disintegrating thousands of portfolios and several ETNs, it’s safe to say it will remain a more volatile year. Valuation and Growth Higher rates and volatility wouldn’t matter if BAC’s underlying business was doing poorly. Thankfully, that’s not the case. The economists at Goldman Sachs recently said there’s almost no chance of a recession in 2018, while continuation of economic expansion bodes well for investment banks. From the analysts’ perspective, they expect BAC’s earnings to expand almost 40% this year and grow another 13% in 2019. Revenue estimates only call for 4.3% growth in 2018 and 4.8% growth in 2019. Still, that earnings growth is very impressive. At current prices, BAC stock trades at just 11.4 times 2018 earnings and about 10 times next year’s earnings. While not massive, it’s also worth mentioning that Bank of America stock also has a 1.6% dividend yield. Wait, BAC is forecast to grow earnings almost 40% this year and trades at less than 12 times earnings? It doesn’t make a lot of sense to me either, but that’s what we’re dealing with. The valuation alone should limit the downside in BAC stock provided the U.S. doesn’t enter a recession — which is quite unlikely at this point.