Updated from 9:53 a.m. ET with afternoon market action and comment from Rafferty Capital Markets analyst Richard Bove.
NEW YORK (
) -- 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.
KBW Bank Index
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) - Get Report 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) - Get Report closed at $52.19 Wednesday. The shares traded for 9.4 times the consensus 2014 EPS estimate of $5.58.
- Goldman Sachs (GS) - Get Report 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) - Get Report shares closed at $14.71 and traded for 10.7 times the consensus 2014 EPS estimate of $1.37.
- Morgan Stanley (MS) - Get Report closed at $27.72. The stock traded for 10.7 times the consensus 2014 EPS estimate of $2.58.
- Wells Fargo (WFC) - Get Report 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.
But for investors who are keen on the state of the banking industry and have been pushing bank valuations up so rapidly, JPMorgan still appears to worthy of consideration as a long-term play. The company earns more money than any other U.S. bank and has remained profitable through thick and thin, and recently reported another quarter of
strong earnings results
, setting records for average loans and credit card sales volume. JPMorgan's second-quarter return on tangible common equity was a solid 17%.
Sterne Agee analyst Todd Hagerman sees 15% upside for JPMorgan's shares over the next 12 months, with a price target of $65.00. The analyst on July 15 raised his 2014 EPS estimate for JPMorgan to $6.30 from $6.15, and he estimates earnings will grow to $6.80 a share in 2015.
Because JPMorgan's results were in part driven by a $1.4 billion release of loan loss reserves, Hagerman in a note to clients wrote "the relative strength of reported earnings is not sustainable in the near term," but added that "JPM's diversified business model offers a fair amount of earnings leverage heading into '14."
JPMorgan's shares were down 1% in afternoon trading, to $56.16.
Rafferty Capita Markets analyst Richard Bove in a Thursday note to investors took a similar tone to Mutascio, in pointing out the risks of an overheated market to investors. When discussing the market environment for large-cap bank stocks, Bove wrote "these stocks are still cheap and that they should be bought," and that investors "look for those that have shown core earnings growth."
However, at this moment, it appears that any bank stock will do as long as it has the name bank in it," Bove wrote. "That is dangerous investing."
Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.
-- Written by Philip van Doorn in Jupiter, Fla.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.