The financial sector has underperformed in 2020. And when looking at just banking stocks, it’s been even worse.
The S&P 500 has bounced back and is close to breakeven for 2020. But bank stocks, on the other hand, are still down 34%. With the 2008-09 financial crash in recent memory, investors have beaten them down. But this time around, the big banks are much stronger.
Bank Stocks Outlook for 2020 and Beyond
In the short-term, it’s not looking great for banks. The spike in unemployment will lead to higher loan losses. And I don’t see it getting better anytime soon. Although, the banks have prepared in a big way…
Three big banks alone set aside $28 billion last quarter for potential loan losses. This should be a good buffer for the recession. And on top of that, banks are limiting new loans and cutting costs elsewhere.
The downturn will continue to strain banks but they’re much better prepared than last time around. This ties into the first of five reasons why I think big banks will outperform long-term…
- Lower Leverage
Big banks today are less leveraged than the past crisis. Bank then, you’d find bank balance sheets leveraged 30-to-1. But today, many are closer to a much healthier 10-to-1. The Federal reserve and other agencies have pushed big banks to improve their balance sheets. On top of that, collateral like homes aren’t seeing a big value drop.
- Government Bailouts
Good old Uncle Sam has stepped in with his printing machine. Free money has definitely helped millions of Americans with their lost jobs, but at what cost? Now, that’s more of a conversation for another time. Instead, the takeaway here is that big banks are too big to fail. And most of the new money sloshing around ends up going to the banks. They can then collect additional fees, etc.
- Financial Sector Growth
The financial sector has grown in tandem with the economy. Of course, there are some short-term blips, but in the long-term, this trend should continue. Money is vital in every other industry and I don’t see that changing anytime soon. Another interesting point is that the financial sector has actually grown faster than U.S. GDP as the country has become more developed.
- Barriers to Entry
With advancing financial tech and government regulations, it’s near impossible for smaller banks to survive. Bigger banks are gobbling them up and improving their economies of scale. This provides wider moats for the big banks. Well-intended regulation can often be a double-edged sword.
- Bank Stock Valuation
I alluded to this toward the start. Investors have beaten down bank stock prices, but have their underlying long-term fundamentals changed just as much? For example, is Wells Fargo really worth 55% or $130 billion less than it was at the start of the year? Maybe, but I don’t think so…
These are just a few of the reasons why I bought shares of Wells Fargo towards the start of the pandemic. I’m down slightly on the position and have been looking for more buying opportunities.
I put close to 10% of my total portfolio in the position so I’m hesitant to double down. There’s always the chance another scandal or other company specific risk comes to fruition. But if it keeps dropping – and the fundamentals don’t change – I might add to the position, or maybe I’ll jump into Bank of America. Warren Buffett just added close to another $1 billion worth to Berkshire Hathaway’s position.
Either way, I think bank stocks provide some of the best long-term return potential. What do you think? Have you invested in any big banks? Or if not, what’s your hesitation? Feel free to drop a comment below.