In our last article, we gave (NYSE:BAC) a rare buy rating. We had the combination of extreme valuations along with several other factors that create extraordinary returns.
Our point is that the story of the relationship carries, even if it will be more long-term, it will take time to do this. There are no one-sided markets, and a recession is likely to give the bond market a breather. BAC will benefit immensely as its thinly purchased held-to-maturity securities will not be lost and undone over time. Overall, we like the stock here and are upgrading it to buy with the expectation of annualized returns of 7%-9% over the long term.
The stock has performed well since then and has even outperformed the broader S&P 500 (SPY) and “magnificent 7”.
We explore the potential for more returns.
What Created Returns?
With a total return of 29% over the quarter, one would think that BAC may have reinvented the wheel or discovered a way to cash in on the AI craze. But this was far from the case. In fact, earnings estimates have reluctantly moved slightly lower over the past 1 month.
What explains this is simply the market pricing in the risks of a severe recession. While there are many metrics to look at this, Baa (the bottom line of investment grade) corporate bond yields and their spreads on US Treasuries have been an excellent inverse indicator for BAC stock.
So as you see yields approach their previous 12-month lows, you have to ask yourself what your outlook is on this and other measures of risk.
Basically, everyone is celebrating possible Fed rate cuts. Not only did Powell not pull back on expectations in his press conference, he hinted that he was more than happy to accommodate the market. The euphoria that followed blew expectations of rate cuts to new lows. We are setting prices now, but no, 6 rate cuts for 2024.
We are doing this with wage inflation still at much higher levels than would be consistent with 2% inflation.
The most perplexing aspect of all this is that the yield curve remains deeply inverted. In fact, the upside has worsened significantly since the Fed’s last meeting.
We can ignore this data point, but history has suggested that it likely will at some point.
So a few things can go wrong here. The first is that inflation rears its ugly head again and the Fed disappoints on rate cuts. The second is that recession finally hits as past rate hikes trickle down and deliver the blow.
BAC remains a bit expensive, if results other than a perfect “soft landing” are achieved. We would see 1.5x book value tangible as the upper limit of what investors will choose to pay with 150 basis points of inversion in the curve.
When we suggested a long sideways bias a few months ago, the rationale was that at book value close to 1.1x tangible you weren’t risking life and limb to make money. At 1.4X you have to take a back seat, especially in light of the growing risks that nobody seems to care about these days. With that in mind, we are now reducing this back to a wait.
In our previous coverage, we had also alerted investors to an excellent income play, Bank of America Corporation 7.25% CNV PFD L (NYSE:BAC.PR.L). These wrecked convertibles were nicely configured for $1,050 at the time the last article was published.
We had a buy rating on them as the bare yield of 6.93% provided a very high degree of certainty of good returns over the medium term. Unfortunately the rally has ruined prospects for anyone entering today. At a yield below 6%, these no longer remotely interest us, and seem risky if any of our suggested outcomes materialize. We downgrade these to a “hold” as well and will switch to an outright “Sell” above $1,300.
Another favorite we’d like to discuss is the Bank of America Corporation 5.875% NCM PFD HH (NYSE:BAC.PR.K). BAC.PR.K has also increased significantly and moved close to the level. We did not have this in a purchase, as its characteristics made it inferior to BAC.PR.L. At this point these are more dangerous than BAC.PR.L. While we still maintain these at a “Hold”, we would switch to a “Sell” if they go above the same level.
A new one we’d like to highlight today is Bank of America Floating Rate Dept. Noncumulative Preferred Stock, Series E (BAC.PR.E). Their payment is as follows.
Non-cumulative variable rate distributions are payable quarterly on 2/15, 5/15, 8/15 and 11/15 to holders of record on a date determined by the board not more than 30 days prior to the date of payment (NOTE: date of ex-dividend is one business day before the registration date). Variable rate distributions will be paid at a rate per annum equal to the greater of three-month LIBOR plus 0.35% or 4.00% per annum.
Source: Quantum Online
LIBOR is adjusted to SOFR and the current yield is quite high, at 6.86%. These may make sense to anyone expecting a radically outside-the-consensus outlook on yields. If you expect rate cuts to materialize only marginally in 2024, followed by higher inflation and new rate hikes, these would be the play. They might also make sense if you’re waiting for the ZIRP era to return. The floor yield of 4% at par (4.5% above the current price) makes them one of the best floating rate issues out there.
Please note that this is not financial advice. It may look like it, it may sound like it, but surprisingly it is not. Investors are expected to exercise due diligence and consult with a professional who understands their objectives and limitations.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.