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JPMorgan Still Among Cheapest Bank Stocks (Update 1)

Updated from 9:53 a.m. ET with afternoon market action and comment from Rafferty Capital Markets analyst Richard Bove.

NEW YORK (TheStreet) -- The market continues to fear the regulatory and political onslaught will threaten profits for the largest U.S. banks for years to come.

At least that's what the stock valuations tell us.

The KBW Bank Index (I:BKX) was up 29% year-to-date through Thursday's close at 66.38, following a 30% return during 2012, underscoring an amazing recovery for the banking sector.

Some market watchers believe bank stocks are now overheated. KBW analyst Christopher Mutascio in a note to clients on Wednesday wrote "The surge in large-cap bank stock prices and P/E multiples do not seem to be supported by reported results given tepid net interest income, revenue and pre-tax pre-provision earnings growth." The analyst sees the market looking far ahead and setting valuations on expected 2016 results, "assuming the Fed doesn't raise short-term rates until 2015."

On the other hand, investors may be "assuming a permanent revaluation of the sector due to higher capital levels that might imply lower susceptibility to recessionnary pressures," according to Mutascio, who added "we think each thesis carries some risk at current valuations."

According to the analyst, Since the day before the start of 1Q13 earnings season (close on April 11), the BKX Bank Index has surged 17% and the P/E multiple for our large cap bank universe has increased a similar 15% (10.0x to 11.5x)."

Investors may want to take note that all "big six" U.S. banks trade at lower forward price-to-earnings multiples than KBW's average of 11.5, for large-cap names:

  • Shares of JPMorgan Chase (JPM) closed at $56.63 Wednesday and traded for 9.3 times the consensus 2014 earnings estimate of $6.09 a share, among analysts polled by Thomson Reuters.
  • Citigroup (C) closed at $52.19 Wednesday. The shares traded for 9.4 times the consensus 2014 EPS estimate of $5.58.
  • Goldman Sachs (GS) closed at $165.04, with the shares trading for 10.5 times the consensus 2014 EPS estimate of$15.68.
  • Bank of America's (BAC) shares closed at $14.71 and traded for 10.7 times the consensus 2014 EPS estimate of $1.37.
  • Morgan Stanley (MS) closed at $27.72. The stock traded for 10.7 times the consensus 2014 EPS estimate of $2.58.
  • Wells Fargo (WFC) was the most expensive among the big six, with shares closing at $44.31 Wednesday, trading for 11.0 times the consensus 2014 EPS estimate of $4.01. Wells Fargo has consistently been the strongest earner among the big six since the credit crisis began. Even though it's the most expensive among these six names, the shares could still see quite a strong run over the next several years, assuming investors' trust in the big banks builds. The shares routinely traded for more than 20 times earnings before the credit crisis began in 2008.

JPMorgan and the other big banks face plenty of uncertainty from the seemingly never-ending regulatory and political onslaught. With the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. together proposing to raise leverage ratio for the nation's largest banks one week after the Fed finalized its rules for implementing the Basel III capital standards, the banks may be getting close to knowing exactly what their full set of capital rules will be, which should provide some certainty to investors.

However, the Volcker Rule's ban on proprietary trading by banks -- and the exceptions that will be made to allow for market-making activities -- still have not been finalized. Regulators also need to fine-tune the leverage ratio requirements after the current comment period expires, which could hamper their ability to engage in securities repurchase agreements. The Fed may also move to reduce banks' ability to participate in commodities businesses.

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