The bull case for bank stocks heading into next year

Kenneth Leon, CFRA Research Director, joins Yahoo Finance Live to discuss the outlook on banks following earnings and looking ahead to next year.

Video transcript

- Want to get back to the banks and take a deeper dive into what we heard from them today and all week long. Goldman Sachs-- Emily just talking about it-- latest bank to crush analysts' estimates on strong investment banking and trading results.

Here to help us break down those earnings reports is Kenneth Leon, research director at CFRA. So Ken, always good to see you. When you take a look at the bank earnings collectively this week, what do they tell you about the health of the banking sector right now?

KENNETH LEON: We can look at this as investors and then as analysts. As investors, this sets up a very strong base quarter for the trajectory of growth into next year. Really, the key drivers are really the beginning of healthy loan growth, a rising rate environment, which is going to be very beneficial to the bank earnings next year, and the ongoing consistent strong capital markets.

These three legs of really the bull case for banks means that for investors looking to play that part of the portfolio for cyclical, you're getting high quality cash flow return of capital and few surprises. There really isn't today. It's amazing. A distressed industry where they really have to build up big reserves.

They did that during the pandemic, but a lot of those were reversed in the last three quarters. But most importantly, let's look today and look at the outlook well into 2022. And these stocks, these large banks are trading at significant discounts to the S&P 500.

Last point on this would be Goldman Sachs and Morgan Stanley which are really higher earnings power companies than the other large banks. They're traded under 10 times earnings. And then you got BlackRock and Schwab trading over 21 times next year's earnings. So I'm not sure they're going to get to that point because cap markets can be cyclical.

But I think you can get some narrowing of the spread on multiples. I think that's the story. James Gorman, the CEO of Morgan Stanley-- he's after a wider multiple for his stock that took Steve Schwarzman of Blackstone, ticker BX, to go through that mantra for several years. But we're getting consistency. And this is good for investors.

- Well, amongst that group-- so you're basically saying Goldman Sachs and Morgan Stanley on a valuation basis look more attractive than their peers heading into 2022?

KENNETH LEON: They have higher earnings power. I mean, they're just driving-- all businesses are firing on all cylinders. When you look at the large banks, you know, these are monolithic consumer lenders and commercial loan. That takes time. They get scale, but they also have a lot of legacy assets as well. So business is a little bit different.

We definitely do like some of the turnaround stories of large banks like Wells Fargo. It's a buy. Bank of America stock did really well yesterday. And it's moved up several points. But at the end of the day, it's just hard to move a Bank of America so large. And it's really hard to say that Morgan Stanley and Goldman are nimble. They just have a better business mix.

They're all attractive. Investors, when they round out playing recovery, well, is it going to happen in consumer? Or we've gotten phenomenal performance in the last three to six months out of energy. But energy really isn't part of the new economy. The large banks are.

- What about your outlook for next year for the big banks? I mean, the Fed has made pretty clear that interest rates are going to start rising, whether it be the end of '22 or the beginning of '23. I would imagine that would just be fertile ground for these banks to continue to do a booming business.

KENNETH LEON: It really is. And you get to kind of like, riding the wave as a bank analyst. Essentially, net interest income is 50% to 60% of total net revenue. It's driven by higher rates and loan volume. We're just beginning to see that. On the consumer side, the card is showing stronger activity as Bank of America said in September.

But then once consumers begin to work down cash balances, you know, will they begin to borrow or increase loan balances? Or there's been a change since COVID. So as folks are more conservative. And they're not going to use 5 to 10 credit cards, buy everything they want.

First of all, you can't get everything you want because of the supply chain. But net interest income is a big engine for the bank earnings next year. I think we're going to be talking favorably about banks well into 2022.

- All right, Kenneth Leon of CFRA. Thanks so much for being with us and talking ba--