Bank Stocks Are Historically Cheap, But May 'Need To See More Pain' Before It's Time To Buy

The SPDR S&P Bank ETF (NYSE: KBE) is down 18.6% year-to-date, only slightly outperforming the S&P 500 as a whole. Rising interest rates are typically good news for bank earnings, but the weakness in bank stocks as of late has been driven by concerns over a potential slowdown in the lending market.

Attractive Valuation: On Monday, Bank of America analyst Ebrahim Poonawala said bank stocks are very attractively valued relative to historical levels, but it may still be too early for investors to buy the dip.

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Poonawala said banks are currently trading at a 46% discount to the overall S&P 500 forward earnings multiple, well below their historical average of a 29% discount over the past 28 years. Given the uncertainty in the U.S. macroeconomic outlook for the next six to 12 months, Poonawala said investors should expect more volatility in back stocks with each round of economic data.

"US/Canadian banks [are] still considered as best-of-breed among developed market banks, but late-cycle mindset (peak EPS/ROE) creates little urgency to add exposure when growth/margins/credit are all expected to worsen over the next 6 to 12 months," Poonawala said.

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He expects any material macroeconomic downturn could drive banks to increase their reserve builds aggressively, a phenomenon which may have already begun in the third quarter.

How To Play It: Poonawala said the uncertainty has created a positive bias toward U.S. megabanks JPMorgan Chase & Co (NYSE: JPM) and Wells Fargo & Co (NYSE: WFC), each of which has a high-quality balance sheet and faces relatively low risk of incremental negative surprises.

At the same time, Poonawla said growth bank stocks, such as SVB Financial Group (NASDAQ: SIVB), Signature Bank (NASDAQ: SBNY) and First Republic Bank (NYSE: FRC) will likely "need to see more pain" before investors can feel confident buying the dip.

Benzinga's Take: Given their far improved balance sheets since the 2008 financial crisis and their historically low valuation, bank stocks seem like an extremely attractive long-term investment at current prices. However, if rising interest rates and persistently high inflation trigger a U.S. recession, bank stocks may still have significant downside ahead in the near term.

Photo: Yulia Grigoryeva via Shutterstock