Bank Stocks Are Oversold

Regional bank stocks are especially cheap

It is a hard problem—telling stocks that are overbought from those that are oversold. Of course, it must be so; markets are indeed efficient to zeroth order. It is not possible to time markets; and, therefore, it is not possible to solve the problem of valuation in an absolute sense. What the sharpest quants can do is pin down relative valuations. This does not work for any specific stock. But it works systematically, in the sense that if you place hundreds of small bets on based on a good relative valuation model, there is alpha to be had—your reward for being more informed than the marginal investor.

I cannot discuss the specifics of our relative value model. But I can tell you that it is not based on misguided kitchen-sink ML. It is based on reason and evidence and nothing else. What our model shows is that bank stocks are now extremely oversold.

As late as last Friday, financials were neither too rich nor too cheap relative to the market. In terms of our metric, the relative value of financials was +0.07%. By yesterday’s close, financials as a whole—the market-weighted portfolio of sixty-four financial services stocks—had fallen to a relative valuation of -3.52%. This sort of fluctuation in normal. Indeed, energy stocks are even cheaper by our metric.

But digging into financials, we quickly discover the mayhem. Large banks have been hammered less than Broad banking; banking has been hammered less than Regional banks.

The whole panic unfolded in a matter of three days. According to my model, big bank stocks are now cheap (-6.6%), bank stocks in general are now cheaper (-7.8%), and regional bank stocks are ludicrously cheap (-18.8%).

Markets are basically pricing in a catastrophe for regional banks in particular, and banking in general. This narrative has no legs because banks are the ward of the US state; they cannot and will not be allowed to fail. So, this nonsense should get priced out soon enough.

I am not convinced by the idea that, while the banks may be rescued, investors in said banks will lose their shirts. That’s very hard to pull off. If policymakers ensure that the banks are secure and profitable—as indeed they must because banks have a gun to their heads—it will be extremely hard for them to impose losses on equity investors holding bank stocks. Ya just can’t square that circle.

In the final analysis, we have a privatized profit-socialized loss system in banking. This structure may be transformed under the weight of its own contradictions. But that sort of regime change isn’t going to happen this quarter.

Traders need to calm the fuck down. There’s not going to be a real banking crisis because the guys with the bazookas are more than willing to do whatever it takes to stabilize the system.