Shares of Bank of America (NYSE:BAC) are up nearly 4% on Friday after the Labor Department's latest jobs report suggested that the recovery from the financial crisis eight years ago is still on track.
Nonfarm payrolls grew 255,000 in July. The results handily outperformed expectations, as analysts had predicted that private sector payrolls would expand by 179,000.
It was the second month in a row that the jobs report showed robust employment gains. After revising its estimate for the previous month, the Labor Department said on Friday that U.S. employers added 292,000 jobs in June.
The results were a welcome relief following months of uncertainty about the recovery. The jobs report in May was particularly dismal, coming in at only 24,000 new positions. It was the worst showing in five years.
Bank of America's shares responded vigorously, outperforming the broader market by a factor of four, roughly halfway through the trading day. There are two reasons for the sharp response.
First, the better-than-expected results further the case for higher interest rates. The Federal Reserve seemed poised earlier this year to continue raising rates, following its 0.25% increase to the federal funds rate last December. But global economic uncertainty surrounding China, Europe, and persistently low oil prices, caused the central bank to back off insinuations that further rate rises were imminent.
It's no exaggeration to say that Bank of America desperately needs higher interest rates. The North Carolina-based bank earned only 6.3% on its average common equity last year, which is half its cost of capital. This means that it's effectively destroying shareholder value when you factor in the opportunity cost of not investing in alternative options.
This issue would be solved if the Fed increased rates. On the bank's latest conference call, Chairman and CEO Brian Moynihan said that a boost of 100 basis points to rates would translate into $7.5 billion more net interest income.
The second reason that Bank of America's shares reacted so sharply today is because it's an innately volatile stock. You can see this by looking at its beta, which measures how much a particular stock moves relative to the broader market.
- A beta of 1 means that a stock moves directly in line with the market -- if the S&P 500 gains 2%, so too will a stock with a beta of 1.
- A stock with a beta over 1 is more volatile than the market -- if the S&P 500 gains 2%, a stock with a beta of 1.5 will gain 3% (50% more).
- And a stock with a beta less than 1 is less volatile than the market – if the S&P 500 gains 2%, a stock with a beta of 0.5 will be up 1% (50% less).
Bank of America's beta is 1.76. Thus, on a day that the broader market is up, as it is today, Bank of America's stock will be up by an average of 76% more.
John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.