Analysts Warn of Potential Valuation Overshoot for Bank Stocks

Bank of America analysts have cautioned investors regarding the risk of an “overshoot” in bank stock valuations due to rising optimism about a soft landing for the U.S. economy and clearer policy directions expected after the upcoming U.S. elections.

They note that bank stocks’ performance so far in 2024 supports their prediction of a higher valuation for these stocks driven by stable-to-rising earnings per share (EPS).

Impressive gains have been observed across bank categories: Mega-cap banks increased by 19.8%, super regionals by 18.6%, trust banks by 10.9%, and small-to-mid-cap banks (SMID-caps) by 9.2%. This contrasts with the S&P 500’s growth of 17.4%.

Despite a less favorable risk/reward profile now compared to earlier this year, Bank of America claims that rising optimism and clearer policies might propel valuations higher. They emphasize that this possible overshoot should be considered by investors.

The upcoming August Non-Farm Payroll (NFP) report is a key factor for the banking sector. The analysts state, “An inline to better August jobs report on Friday could serve as an all clear for generalists to add exposure to bank stocks given the strong correlations between the unemployment rate and credit losses.”

Furthermore, it is noted that dedicated bank investors are particularly wary of risks stemming from lower interest rates, whereas generalists are focused on credit quality and the prospect of enhanced customer engagement next year.

Historically, investing in bank stocks before and after U.S. elections has been beneficial, reinforcing Bank of America’s view of a potential valuation overshoot.