Are Banks As Big a Bargain As They Look?

For a while on Friday, it appeared that the S&P 500 (^GSPC 1.20%) would close down 20% from its all-time highs, prompting calls that Wall Street was in a bear market. On an intraday basis, the S&P did get far enough lower to trigger that call, but a late-day rally brought the index back into positive territory. The Dow Jones Industrial Average (^DJI 0.69%) also finished in the green, and the Nasdaq Composite (^IXIC 1.59%) ended with far smaller losses than just a couple hours before the close.

Data source: Yahoo! Finance.

As growth stocks take big hits, some investors are seeing the opportunity to tap into an investing style they haven't paid much attention to in years. Value investing is back in vogue, but it hasn't necessarily worked all that well in 2022 either. Looking at big bank stocks, companies like JPMorgan Chase (JPM 1.44%), Bank of America (BAC 1.70%), Wells Fargo (WFC -0.26%), and Citigroup (C 2.82%) are trading at attractive valuations, yet they've posted substantial losses. Below, we'll look more closely to see why bank stocks are giving mixed signals and whether they really represent a true bargain.

Banks: Low multiples, big losses

When you look at the earnings of the largest banks in the U.S. compared to their share prices, you'll find few stocks that look more inexpensive. JPMorgan and Wells Fargo trade at less than nine times earnings, while BofA has an earnings multiple just below 10. Citigroup takes the prize with a trailing price-to-earnings ratio of less than six.

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Yet even in an environment in which value investing has gotten more popular, these stocks aren't doing well. Wells Fargo and Citigroup are down 13% and 18% respectively so far in 2022. Declines for BofA and JPMorgan have been more severe, nearing the 25% level.

The quandary banks face

Many investors have turned to bank stocks because of the rising interest rate environment. Banks have the reputation of being good ways to benefit from higher rates, because they can sometimes give lending institutions the chance to increase the spread between what they have to pay depositors on checking and savings accounts and what they can charge borrowers in interest on their loans.

However, the problem with the current interest rate environment is that it's not quite as obviously beneficial for big banks. It's true that long-term interest rates have risen sharply, with the 30-year Treasury climbing from around 1.75% to 3% in the past six months. Mortgage rates have gone up even more dramatically, and commercial lending rates have likely risen largely in lockstep with longer-term Treasury bonds. Yet short-term rates are also going up, and investors see the Federal Reserve continuing to boost its Federal Funds rate well into the future.

As a result of the movements at both ends of the yield curve, net interest income might well not rise much or even at all. That could stop the profit growth that many shareholders have hoped to see.

Meanwhile, several of these banks also have exposure to the investment side of the financial markets. If falling stocks and an economic recession lead to a slowdown in initial public offerings, mergers and acquisitions, and other transactions, then these banks could see a hit to the other side of their business. Moreover, with several big banks having focused more on wealth management in recent years, the declines in client assets from the market downturn could also weigh on profits.

Relatively low stock prices give bank stocks a margin of safety over other companies that are exposed to the economy. However, they're not recession-proof, and with the potential to see earnings decline from current levels under certain circumstances, there's a reason they trade at their current valuations.