Bank Stocks Are Doing Great, but It's Time to 'Take the Money and Run' — Barrons.com

By Martin Baccardax

Billionaire Warren Buffett had a simple maxim for navigating Berkshire Hathaway through the financial crisis of 2007-09.

"A simple rule dictates my buying," he wrote in his annual shareholders letter in the winter of 2009. "Be fearful when others are greedy, and be greedy when others are fearful."

It was solid advice.

Stocks bottomed that March, down an astounding 56%, and began a relentless rally that was only upended, however briefly, by the Covid pandemic. Today, the S&P 500 is nearly 1000% higher than it was when Buffett advised greed over fear.

Bank stocks haven't had that sort of run, but they've booked impressive gains, nonetheless.

The benchmark KBW bank index is up nearly 130% over the past three years, with more than half of those gains coming from the Liberation Day tariffs selloff. JPMorgan Chase, Goldman Sachs, Morgan Stanley, and Bank of America hit fresh all-time highs this month.

And that might mean it's time to look for the exit, wrote Oppenheimer's Chris Kotowski and John Coffey.

The pair downgraded Goldman Sachs and Morgan Stanley to Underperform from Perform, and tBank of America and Citigroup to Perform from Outperform,. Banks report their second-quarter earnings in a couple of weeks.

Investment banks are trading at historically high multiples, Kotowski and Coffey said, with baked in estimates of booming merger activity and strong trading books. But high levels of leverage and concerns tied to the next stage of a "fear cycle" in U.S. stocks suggest those levels might be too lofty.

"We're going to err on the side of being fearful when people are greedy, " they said. "We do not have any great insights into what will cause the next great 'fear cycle' or when it will happen (but) our instinct is that trading activities currently probably pose a greater risk than traditional lending."

Kotowski and Coffey pointed out that equity markets, now robust for four years running, are concentrated just a few stocks, "and those names are really big and really volatile."

"Thus, we fear that it is only a matter of time that we discover that mega fund (or group of mega funds) zigged when they should have zagged and then there is a problem," they wrote.

There's definitely been some weakness in the sector. Goldman shares have fallen nearly 8% since peaking in late June, just after the Federal Reserve's annual stress tests, and Morgan Stanley is down around 7%.

Those declines are interesting, especially heading into what Wall Street expects will be a solid earnings season. Financial stocks, afterall, are set to contribute around 16.5% of the S&P 500's overall profit tally of $699 billion.

Markets have also seen a pullback in Treasury bond yields, a moderation in bets on Fed rate hikes, and one of the biggest quarterly declines in global crude prices on record, which suggests easing inflation pressures over the back half of the year.

Big IPO deals, including Anthropic's planned debut and a $29 billion U.S. float for South Korean chip maker SK Hynix, are expected in the coming months. Goldman alone has managed a record $1 trillion worth of deals over the first half of the year, according to Dealogic data, including its lead underwriting position on the SpaceX market debut.

Loan growth, meanwhile, is largely matching the advances in nominal GDP, while credit delinquency rates have been in decline for much of the past two years.

Looking at next year, Oppenheimer sees higher earnings growth, including for Goldman and Morgan Stanley, as U.S. banks take a larger share of global investment banking.

Still, Kotowski and Coffey think it might be time to go the other way, saying there's at least some fear over the market's greed-based assumptions.

"While we readily admit that there is nothing on the fundamentals that strikes us as particularly worrying at present, we continue to believe that both commercial banking and investment banking are pretty mature and cyclical businesses," Kotowski and Coffey said.

"The cycle may well go on for another 12 to 18 months or more, we'd rather not wait around for the warning signs to appear, and thus particularly in the case of the investment banks we are more inclined to take the money and run."

Write to Martin Baccardax at martin.baccardax@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.