It seems like every week another high-profile investor issues a warning about the levitating state of asset markets. No one can predict the future, of course, but if they're right and the market proceeds to correct, then investors in a bank like Bank of America (NYSE:BAC) could be in an advantageous position.
A growing chorus of concern
The latest high-profile investor to issue a warning is Jeffrey Gundlach, the co-founder and chief executive officer of DoubleLine Capital, a fund with $110 billion in assets under management.
Gundlach says risky assets like junk bonds and emerging-market debt are overvalued. As a result, he's decided to reduce those positions in exchange for higher-quality assets with less sensitivity to rising interest rates or a falling market.
"If you're waiting for the catalyst to show itself, you're going to be selling at a lower price," he told Bloomberg News in a phone interview on Monday. "This is not the time period where you say, 'I can buy anything and not worry about the risk of it.' The time to do that was 18 months ago."
Gundlach's warning follows a similar one issued at the end of last month by Howard Marks, a revered value investor and the co-chairman of Oaktree Capital Group (NYSE:OAK).
"[I]t's essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature," writes Marks in his latest memo. "I think it's better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses."
Even Warren Buffett has chimed in on this, alluding to the possibility of a correction in his letter to shareholders of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold," he wrote. "When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do."
To this end, Berkshire Hathaway is holding just shy of $100 billion in cash that's waiting to be deployed when the opportunity presents itself.
Is Bank of America a safer bet?
Whether the market takes a turn for the worse in the near future is impossible to predict, but we do know that corrections happen regularly and also that we haven't seen one in a while. Either way, when one inevitably does occur, there's reason to believe that Bank of America's stock is better positioned to absorb it than most other stocks.
In the first case, as I discuss here, Bank of America's shares trade for the third lowest price-to-book-value multiple on the KBW Bank Index, which tracks shares of two dozen large-cap banks. Bank of America's shares thus seem to have less downside than other higher-priced bank stocks.
Additionally, one of the catalysts that could cause stocks to fall are rising interest rates, which have already begun to tick higher. This follows from the fact that interest rates and asset prices tend to be inversely correlated. As rates rise, stocks should fall, and vice versa.
But rising rates are a good thing for Bank of America, which will earn more money from its loan portfolio as rates head higher. In its second-quarter 10-Q, Bank of America discloses that a 100-basis-point increase in short- and long-term rates should translate into an additional $3.2 billion worth of net interest income over a 12-month period. That's a healthy chunk of change for a bank that earns between $4 billion and $5 billion in net income each quarter.
In short, while it's impossible to say whether DoubleLine's Gundlach, Oaktree Capital's Marks, or Berkshire Hathaway's Buffett are right about a potential correction in the market, shareholders of Bank of America have reasons to be less worried about such an event than do investors in other stocks.