It’s been a great September for shares of banking giant JP Morgan Chase (NYSE:JPM). Month-to-date, the JPM stock price is up nearly 10%, handily outpacing the S&P 500 index’s 2.5% gain in September. But, JP Morgan stock is doing more than outperforming the broader markets recently. Over the past two weeks, the shares are up 14%, marking the stock’s third best two-week-stretch in five years.
That’s right. JPM stock over the past two weeks is basically as hot as it’s ever been in the past five years. At this point, two questions should come to mind: One, why has JP Morgan stock been so hot? Two, can it stay this hot?
In short, JPM stock has been super hot because of a convergence of macro tailwinds which have dramatically improved banking conditions over the past few weeks. The convergence of these tailwinds has happened at an impressive pace, hence the rapid gain in JPM stock. This impressive pace is unlikely to persist. At the same time, JPM stock is entering unsafe territory from a valuation perspective. Net net, then, it doesn’t look like the stock has much more gas in the tank.
The implication? Current strength in JP Morgan stock isn’t here to stay. Instead, history says that what comes next may not be pretty.
Why JP Morgan Stock Has Been So Hot
JP Morgan stock has risen 14% over the past two weeks for three big reasons.
First, investor sentiment regarding the U.S. economic outlook dramatically improved during that stretch. Specifically, throughout the summer, investors were concerned about a looming recession. Those concerns have backed off over the past few weeks as U.S. economic data has continued to come in much better than expected. Just look at Citi’s Economic Surprise Index, which measures how U.S. economic data is coming in relative to Street expectations. That index has been skyrocketing higher recently, and just popped into positive territory for the first time since early 2019.
As investors have grown more confident on the U.S. economy, they have piled back into economy-sensitive stocks, such as banking stocks like JPM.
Second, the long end of the yield curve has marched higher as investors have grown more optimistic about the U.S. economy. Throughout the summer, as investors grew more and more pessimistic about the trade war and a global economic slowdown, they piled into U.S. Treasuries, pushing the yield on those Treasuries lower. The result? The 10-Year and 30-Year yields basically fell to all-time lows. In the past two weeks, however, investors have sold Treasuries as the economic outlook improved, and the entire long end of the yield curve has marched essentially 40 basis points higher in September.
That’s a big move. When yields go up, banks make more money from interest fees. Thus, as yields have marched higher, bank stocks have marched higher, too.
Third, the yield curve is un-inverting. At the beginning of the month, the 3-Month U.S. Treasury yield was essentially 40 basis points above the 10-Year Treasury yield, which was at the same level as the 2-Year Treasury yield. Now, the 10-Year yield is 10 basis points above the 2-Year (so, back to normal), and only 6 basis points below the 3-Month (so, getting back to normal).
That’s important for banks, which live and die by the yield curve. Thus, as the yield curve has normalized, bank stocks have rallied.
Why The Stock May Cool Down
The aforementioned tailwinds — an improving economic outlook, rising yields, and a normalizing yield curve — have converged rapidly over the past two weeks. This rapid convergence has fueled a rapid rally in JPM stock.
Unfortunately, I don’t think there is much left in this rally — for two big reasons. First, the powerful tailwinds which have sparked this rally will start to moderate and slow. Second, the valuation underlying JPM stock is overextended, and only justified if the aforementioned tailwinds keep up their impressive pace — which they won’t.
On the first point, while the U.S. economic outlook is improving, the trade war is still a very real threat, economic activity is slowing, business confidence remains relatively depressed, inflation is muted, and the Fed appears positioned to cut. Given all those conditions, it seems unlikely that yields continue to march at higher by 40 basis points every two weeks for the next few months. Instead, it seems much more likely that yields simply inch higher from here, and remain very low in the big picture.
If yields do remain low, then the yield curve won’t normalize at a rapid rate, nor will it become that normal anytime soon. Instead, for the foreseeable future, the yield curve will likely look pretty flat.
Thus, while JPM stock is rallying big right now on surging yields and a normalizing curve, the end result here is that rates will remain low (relative to historical standards) and the yield curve will end up flat. Those aren’t great conditions for JP Morgan, so the recent rally in JPM stock may dry up as investors start to realize that while things are getting better for banks, they aren’t getting good.
On the second point, the recent rally in JPM stock has fueled the stock’s price-to-book multiple to above 1.6x. That’s unsafe territory for this stock. Over the past decade, JP Morgan stock has traded above 1.6x book only three times. First, in early 2018, before JPM stock shed 10% in early February 2018. Second, in mid-2018, before JPM stock lost 20% in the late 2018 market sell-off. Third, in April 2019, before JPM stock lost 10% in May.
In other words, history says that JPM stock is out over its skis here, and that this rally could soon lead into a sell-off.
Bottom Line on JPM Stock
When it comes to the banking sector, JP Morgan stock is about as good as it gets. This company is innovative, has a great management team, and always seems to be on the ball with changes in the financial landscape. But, at the current moment, JPM stock seems like a tough buy — both because current banking industry tailwinds will likely moderate and because JPM stock isn’t priced for such moderation.
As such, while I’m a fan of JP Morgan the company, I don’t think JPM stock is the best buy at the current moment.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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