It’s clear that traders believe a U.S.-China trade deal could have a negative impact on interest rate-sensitive stocks such as REITs, with many of the blue-chip names down 2-3% on Thursday amid reports that a deal was close to being reached. It appears as though these fears are focused on the possibility of the normalization process and rates being raised again once trade tensions are behind us. If this is true, however, there will be beneficiaries as well. Namely, the big banks.
Although the Federal Reserve has cut rates several times throughout 2019, it’s important to remember that prior to the trade war with China, the Fed was headed in the other direction.
During the first year of the President’s term, the Trump tax cuts and deregulation plans jolted both the market and the economy. We saw the Trump rally play itself out, with cyclical stocks booming as some of the greatest beneficiaries of new policies. The economy was experiencing an uptick in growth, and employment figures continued to improve, eventually resulting in record low unemployment. Wages began to rise, consumer sentiment was high and CEOs were confident as well.
All of these signals pointed towards a strong economy, justifying rising rates. Jerome Powell seemed intent on normalizing rates with three increases in 2017 and 2018. While there was some pushback from certain economists (and the President), the normalization process was great for the big banks, who saw their net interest margins increase, resulting in strong bottom-line performance.
JPMorgan Chase is widely considered to be the best-in-breed name amongst the money center banks. This company saw its earnings-per-share grow by 31% in 2018 and if the normalization process begins again in the short-term, JPMorgan will see profits soar once again.
As rumors revolving around the trade talks became more positive, the market began to rotate back into more cyclical names. Shares of JPMorgan have risen roughly $30/share since Sept. 1, up from $109 to the $139 area where they trade today. Yet, if a trade deal gets done, I think this move could be far from over.
Right now, analysts are only estimating that JPMorgan will produce 2% bottom-line growth in 2020. The market is fairly bearish on growth prospects with the rate increases from 2018 no longer being factored into comparable year-over-year numbers. Instead, management must contend with the three cuts that we’ve seen in 2019. But the market’s recent rally could be pointing towards a change in Fed policy and if this occurs, the multiple expansion in the financial space still has room to run.
Even after their Q4 rally, J.P. Morgan shares remain relatively cheap at a trailing twelve month price-to-earnings ratio of just 13.3x. In early 2018, shares reached a peak valuation of approximately 16x trailing earnings. If shares were priced with that same bullish multiple today, we'd be talking about a share price north of $165.
Obviously it takes a big leap to go from reports about a trade agreement being reached to Jerome Powell raising rates again. But things can change quickly in Fed-land. In Sept. of 2018, very few people would have predicted that a year later, the Fed would have made an about face, lowering rates three times. So if a major trade deal gets done, it wouldn’t totally surprise me if we’re sitting here a year from now, saying the exact same thing about a change in Fed policy over the coming 12 months.