Sector Valuation
Our Current Valuation for the Banking Sector is:
Fully Valued
We assessed the banking sector as Fully Valued at the beginning of 2024, and maintained that rating until July when we determined the sector was under valued relative to the broader market. After the Summer rally and the Fed rate cut in September and reduced outlook for further cuts, we deemed the sector fully valued until the middle of October when earnings were coming in better than expected. Although we changed our outlook to undervalued at that time, admittedly we did not foresee the huge valuation spikes immediately after the election. We did believe that this euphoria was somewhat misplaced and have now changed our rating for the banking sector to fully valued and expect it to mirror the broader market over the short term.
The RJR Indicator: Negative
We do not issue buy, sell or hold recommendations on individual companies. Rather, we evaluate each of our target banks along a number of performance attributes, assign an overall score to each bank, use a variety of statistical models to determine target valuations, and then assign a rating based on our assessment of relative valuation.
Over time, we have found that the movement of our under and overvalued banks is a strong predictor of, not only banking sector price performance, but of the direction of the market, overall. This has led to the development of the "RJR Indicator". Essentially, when our banks rated undervalued outperform those rated overvalued, the direction of the market is positive. The opposite is also true. The RJR indicator is triggered when the performance lines cross. Both the quarterly and weekly RJR indicators have been sending mixed signals over the past year, however there have been a few clear signals which we highlight when the indicator changes. For the last six months the indicator has been either neutral or slightly positive indicating movement consistent with the overall market. However, it did trend slightly positive on a weekly basis at the end of October at which time we highlighted a slight positive signal. Again, we did not anticipate the election surge so that was just a fortunate (?) coincidence. After the post-election rally, our indicator turned neutral at the end of the year and has remained there until the most recent week. Based on fourth quarter and year end financial reports, we adjusted our list of over and undervalued companies. This had an impact on the direction of the indicator, which began signaling caution in January. We have changed our rating to NEGATIVE for only the second time in two years and continue to urge caution until the potential impact of proposed tariffs on both the inflation and interest rate outlook becomes clearer.
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Are Banks on Sale?
Currently out answer is NO based on our target prices. However, consensus analyst price targets are, in some cases, significantly higher than ours, indicating substantial upside potential. Over the past quarter, analyst projections have been more accurate than ours. However, based on the risk we see in the market, we are comfortable with our more conservatives targets. As a result, we believe the sector on the whole is Fully Valued relative to the overall market, although we believe that there continue to be a few highly rated companies that are trading at discounts to our target prices, primarily in the smaller Super Community segment. We have identified those opportunities in the Current Valuation tab in our Members Sections.
Since the beginning of the third quarter, the banking sector has significantly outperformed the broader market, with all size segments participating in the rally. A major impetus of this rally has been the interest rate environment, the ability of most banks to maintain relatively strong interest margins, and the fact that many pundits dire warnings of the collapse of the CRE market in most cases did not come to pass. During most of that time, our banks rated undervalued slightly outperformed both those rated overvalued and the banking sector index overall. While we expect the banking sector to continuer to mirror the overall market over the immediate term, the wild card is how the markets and investors factor in the potential impact of the policies of the incoming administration on both the overall economy and the banking industry specifically.
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