Bank stocks are ‘too cheap’ and could outperform S&P 500 after recession strikes, Oppenheimer says

Published Fri, Jul 29 202212:44 PM EDT

Bank stocks have sold off this year on fears that a looming recession will rock the sector with surging loan defaults. But that reflex is an example of recency bias and ignores a few key differences in the U.S. financial industry after the 2008 financial crisis, Oppenheimer analyst Chris Kotowski said Friday in a research note. "The narrative has shifted to the notion that inflation is so hot that the Fed will have to raise rates so much that it will push the economy into recession, and if we are going into recession, then you know for sure that you don't want to own any bank stocks," Kotowski said. When examining the last three recessions, Kotowski said investors are spooked at the possibility of another 2008 situation, in which bank stocks are at the epicenter of financial distress because of the housing bubble. In that cycle, bank stocks didn't hit bottom until late into the recession — a good reason to avoid the sector now if you thought a repeat was coming. "If you look at the 2008 recession, you see what everyone is afraid of," the analyst said. "The banks did not bottom until late in the recession, and the stocks were weak and volatile for years afterward." But the current environment reminds Kotowski most of the 2001 recession, not 2008, he said. "We don't see an excess of commercial or residential real estate or other large long-lived assets," Kotowski said. "Indeed, the bank numbers with very strong loan growth and rising interest rates still indicate a very robust economy. Maybe less is being spent on certain goods, but spending on services and T & E seems robust." And in the 2000-2001 analogy, bank stocks bottomed well before the official onset of recession — 13 months, according to the analyst. Most of the sector's gains back then came in those turbulent months before the onset of recession, he added. "If one had waited around for the recession to hit, one would have missed a 29.5% gain in the BKX during a period in which the S & P declined by 8.6%," Kotowski said. "That is a heck of a relative performance move to miss out on." In the previous 1989-1990 recession, bank stocks bottomed early in the recession and partly recovered by its end, he added. So every recession is different and the fixation on 2008 is purely recency bias, he concluded. Thanks to a far stricter regulatory regime, better underwriting standards and capital levels that have roughly doubled since the 2008 crisis, banks are in far better shape to contend with the next recession, according to the analyst. "We expect that whenever the next recession does come the banks' asset quality will remain considerably better than commonly feared and that the group will re-rate to its historical levels," Kotowski wrote. The sector as a whole is "too cheap" as it trades for about 50% of its relative price to earnings, versus a historical average of more than 70%, the Oppenheimer analyst wrote. While Kotowski said that Goldman Sachs , Citigroup and Silicon Valley Bank are probably the cheapest banks to buy now, he favors Bank of America , U.S. Bancorp and "to a lesser extent" JPMorgan Chase . That's because they stand to benefit most from sharply rising interest rates and robust loan growth, which will power their core banking operations, boosting revenue beyond expense growth, he said. "Perhaps there is more upside over the long term in some of the other names, but the upside here is strongly positive as well, and we would expect it to work through sooner," Kotowski said. "We think the operating leverage at BAC and USB will be very apparent over the next 2-3 quarters."