Buy high-upside stocks in one specific corner of the financial sector as recession chatter gets louder, BofA says
- Shares of credit card issuers like American Express and Capital One could provide upside despite recession concerns, BofA said.
- Credit losses should be mitigated in part by healthy balance sheets among consumers who saved money during COVID lockdowns.
The slide in stocks this year partially reflects expectations the US will drop into a recession, but shares of American Express, Capital One and those of other credit card companies could weather a potential downturn in the consumer-driven economy, according to Bank of America.
"We think that the pure-play card issuers – American Express, Capital One, Discover Financial Services, Synchrony Financial [and] Bread Financial (BFH) – could offer attractive upside as investor attention refocuses on their cheap valuations and healthy balance sheets," BofA analyst Mihir Bhatia wrote in a note published this week. "While we appreciate the current degree of macro uncertainty, our analysis suggests that the companies are better positioned to withstand a weaker macro backdrop than many expect."
The Federal Reserve is set on June 15 to deliver its third interest rate increase this year that could bring the fed funds rate to a range of 1.25% to 1.5%. While more expensive borrowing costs make lending more profitable, financial sector stocks have been knocked back by fears the fast pace of rate hikes to combat hot inflation will tip the world's largest economy into recession.
JPMorgan CEO Jamie Dimon this week said an economic "hurricane" is on the horizon and banks should prepare for a recession.
"Consumers are facing headwinds in the form of increased prices and increased interest rates. So buying the product or borrowing money to buy the product will become more expensive as time goes on," Sam Stovall, chief investment strategist at investment research firm CFRA, told Insider. "And if we do fall into recession, and corporations react the way they traditionally do to recessions, that tends to lead to hiring freezes or outright downsizing."
But analysts at Bank of America are optimistic that consumer finance stocks will rebound from a sell-off that saw Synchrony lose more than 20% and Bread Financial roughly 18%.
Economic concerns are already priced into card stocks, most of which are trading below historical averages under a recession scenario, BofA said. "Overall, this suggests that valuations are undemanding, which could set the stage for card companies to deliver strong returns should investor confidence in the earnings power of the card companies increase."
Recession Impacts
BofA said credit losses are likely to drive higher from levels that were artificially held down by student loan forbearance programs and fiscal stimulus from earlier in the pandemic. But its base case is for credit to normalize without major deterioration, noting a healthy labor market, still-strong consumer balance sheets, and robust underwriting standards.
Economists at Bank of America see a 1-in-3 chance of a recession in 2023, and their base case is for there to be an extended period of weak growth and for any recession to be mild.
In a somewhat mild to average recession scenario, BofA's analysis suggests that per-share earnings would be 15% to 30% lower for card issuers. American Express would have the lowest impact as it has a super-prime customer base. At Bread Financial and Capital One, sub-prime customers comprise 39% and 30% of loan balances, respectively.
BofA said the most important macro variable to watch is the unemployment rate, though an uptick due to more labor force participation would be less worrying than an increase due to layoffs. The Labor Department's May jobs report released Friday showed the unemployment rate steady at 3.6%. Payrolls increased by 390,000, outstripping expectations of 325,000 additions.
"A vast majority of consumers typically act rationally and will pay at least their minimum payments if they have a job and can afford to," said Bank of America.
