Morgan Stanley: Bank stock sell-off is overdone

Published Mon, Jun 20 201610:12 AM EDT

The pullback in financial stocks this year is a buying opportunity, Morgan Stanley told clients Monday, recommending an overweight stance on the group. "We have been overweight the financial sector since April 2015 and continue to see multiple compelling reasons for outperformance in the near future," the firm's equity strategist, Adam Parker, wrote in a research note. "The case for overweighting financials is a combination of weak positioning, improving deal volume, limited currency sensitivity, high growth in shareholder return, and a very low price." Year to date, the S & P financial sector is the worst performing group in the S & P 500 index, down 5 percent through Friday, due to uncertainty over the Fed's next move regarding higher interest rates, which benefit bank stocks. Bank stocks surged at the open of trading Monday. Source: FactSet 1. Attractive valuations The recent rout in financial stocks caused multiples to contract, with banks now trading at a 0.92 price to book ratio compared with 1.1 times in July, according to Parker's analysis. 2. Economic fundamentals remain solid The sell-off in financial stocks would imply that investors are expecting a significant deterioration in fundamentals or even a recession, Parker said, adding that such concerns as "overblown." "We believe the risk of a U.S. consumer recession is overblown and the probability of this scenario occurring is low," he said. 3. Compelling dividend yields "Financials currently have a total yield of 3.95 percent, and have experienced the largest increase of the 10 sectors since July 2015," his report says. 4. A strong dollar is positive for banks "We find comfort in banks not being negatively impacted by arguably one of the key macro concerns at the moment. In fact, historically, banks and diversified financials were the only industries that have a positive and statistically significant relationship to the stronger dollar once the market is accounted for," Parker said. Apart from the factors listed above, Morgan Stanley analysts point out that hedge funds' net exposure to financial stocks remains near a record low, a contrarian indicator that could be bullish for the group as money flows back into these stocks should a rally materialize. The Money Play: For investors looking to gain exposure to individual names, the firm recommends focusing on credit cards and alternative asset managers such as Capital One Financial , Discover Financial , Synchrony Financial , JPMorgan , Goldman Sachs and Bank of America (All rated overweight by the firm).

Pedestrians walk past a Capital One ATM outside of a bank branch in New York.

Craig Warga | Bloomberg | Getty Images

The pullback in financial stocks this year is a buying opportunity, Morgan Stanley told clients Monday, recommending an overweight stance on the group.

"We have been overweight the financial sector since April 2015 and continue to see multiple compelling reasons for outperformance in the near future," the firm's equity strategist, Adam Parker, wrote in a research note. "The case for overweighting financials is a combination of weak positioning, improving deal volume, limited currency sensitivity, high growth in shareholder return, and a very low price."

Year to date, the S&P financial sector is the worst performing group in the S&P 500 index, down 5 percent through Friday, due to uncertainty over the Fed's next move regarding higher interest rates, which benefit bank stocks. Bank stocks surged at the open of trading Monday.