Get Premium to unlock powerful stock data

Uncertainty Yields Opportunity

Wells Fargo and Citibank are undervalued

Author's Avatar
Mark Yu
Jul 02, 2020
Article's Main Image

Thursday’s job report delivered another surprise to forecasters and economists as figures logged another new unexpected record. Meanwhile, Treasury yields offered solace to the heavily penalized big banks.

The U.S. recorded its biggest job increase ever at 2.5 million gains in the month of May. The resilient labor market then delivered another feat this Thursday morning by adding 4.8 million more jobs in June.

Most of the gains in May were attributed to individuals who had been furloughed due to the coronavirus returning to work as well as the large number of workers who were classified as employed but absent from work per the Bureau of Labor Statistics. June’s job gains, on the other hand, were a result of the U.S. economy slowly reopening while the pandemic continues.

In total, the labor market has recovered 7.3 million jobs from the peak of 30.3 million back in March. This translates to a current unemployment rate of 11.1%, down from the high of 15% just three months ago.

These numbers easily trounced Wall Street estimates by 11.2 million in total for the last two months and a high unemployment rate that was initially expected to skyrocket to 19.5%. In comparison, the Great Depression's peak unemployment rate was 24.9%.

The Federal Reserve expects the unemployment rate to fall to 9.3% by the end of this year and to 6.5% by the end of 2021.

In a statement, President Donald Trump said, “Today’s announcement proves that our economy is roaring back. It’s coming back extremely strong.”

Through this ongoing health crisis, the financial and energy sectors have suffered the worst.

Some poorly managed energy companies that cannot survive with low oil prices have thrown in the towel and filed for bankruptcy, one of the most notable of which is Oklahoma-based Chesapeake Energy Corp. (

CHKAQ, Financial).

Banks, meanwhile, have received far more criticism from the Federal Reserve as liquidity issues began to freeze the cash market in March, leading to the trillion-dollar bazooka the central bank launched to stabilize the economy.

Energy stocks have fallen nearly 40% while the market valuation of banks, on average, have fallen a little more than 20% so far this year.

Accompanied by the poor performance year to date brought by deep uncertainties related to the pandemic, banks, on average, now trade at a big discount to their book value with a median of 0.74.

The big four banks—JPMorgan Chase (

JPM, Financial), Bank of America (BAC, Financial), Citigroup (C, Financial) and Wells Fargo (WFC, Financial)- now have an average price-book ratio of 0.84.

Citigroup now trades at 0.61 times its book value, while Wells Fargo trades at 0.63 times book value. These figures are far less than their recent historical averages. Citibank would have a potential gain of 20% and a 74% upside with Wells Fargo’s shares should the San Francisco-based bank return to its five-year multiple average.

In addition to the incredible jobs numbers report on Thursday, the major banks performed well enough on the recent Federal Reserve stress tests that warranted them to continue paying out dividends to shareholders, with the exception of Wells Fargo.

“We expect our second quarter results will include an increase in the allowance for credit losses substantially higher than the increase in the first quarter," CEO Charlie Scharf said in a statment. "Wells Fargo continues to have one of the strongest capital positions relative to regulatory minimums among the world’s financial services firms as demonstrated by our stress test results. These are certainly extremely challenging times for many and we remain committed to supporting our customers and communities, and we will continue to take appropriate measures to maintain strong capital and liquidity levels and to improve the earnings capacity of the company.”

With this, investors are now aware that Wells Fargo’s 8% dividend yield is a mirage and should not be taken into account when considering it as an investment.

The main reason why an investor would consider buying into Wells Fargo will be its huge discount to its book value and the already drawn down negative sentiment on its dividend-paying capability that in the slightest positive change in economic circumstances it would be able to trim much less to its payout might relieve some pressure on its shares. Currently, Wall Street estimates that the bank may need to cut more than 50% of its current payout.

On the other hand, Treasury yield curves have stayed away from inversion, which is very unhealthy for banks’ margins, and has maintained the course of an even healthier 51-basis point difference compared to its year-ago difference of 22 basis points. Although studies have argued that a yield-curve flattening—meaning less basis point difference—is more profitable for the big banks, a fatter yield curve would be all-inclusive and better for banks regardless of their asset sizes.

In summary, the direst scenario has already been priced in in the financials sector, so the slightest beat can get the badly wounded stocks back on track.

Disclosure: Long JPMorgan, Bank of America and Wells Fargo.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
Rating:
0 / 5 (0 votes)

Please Login to leave a comment