Why This Banking Stock Might Be Nearing the Bottom of Its Cycle

Key Points

• Wells Fargo shares are trading lower the day after the bank announced its latest quarterly earnings results.
• While some metrics may be alarming, savvy investors will realize that this may signal the bottom of the cycle for the stock.
• Some on Wall Street still see double-digit upside for Wells Fargo stock, and bears are running scared.

The second quarter of the 2024 earnings season has just kicked off, and the financial sector is again under the spotlight. Bank stocks are leading the pack in letting markets know how the economy is doing so far into the year's second half. However, not all bank stocks are made equal. There are typically two extremes and a middle ground regarding exposure to the business cycle.

On one side, there are investment banks, which are highly exposed to interest rates and the business cycle, as the level of mergers and acquisitions (M&A) activity is dependent on these same factors, and so are the profits in this business branch, these banks include names like Goldman Sachs Group Inc. NYSE: GS. On the other hand, commercial banks depend on the consumer cycle instead, with products like mortgages and credit cards.

This commercial area includes Wells Fargo & Co. NYSE: WFC, which just reported its second quarter 2024 earnings results, and markets are not reacting well. The shares of Wells Fargo are trading lower by 6.5% during the trading session. Still, despite this initial reaction to earnings, there are ways investors can support a thesis behind Wells Fargo stock nearing the bottom of its cycle.

Wells Fargo's Product Line Primed for Growth in the Coming Quarters

Considering that Wells Fargo operates heavily in the consumer sector, including products like credit cards and mortgages, investors should look deeper into the drivers that might help these segments bring more significant profits to Wells Fargo.

According to the CME's FedWatch tool, the Federal Reserve (the Fed) is promising interest rate cuts that could hit the stock market as soon as September 2024. Thus, these products are filled with tailwinds that could create a high-demand trend.

Lower interest rates mean lower credit card annual percentage interest (API) and cheaper mortgage rates. While lower interest rates on sold mortgages could affect the bank's net interest income (NII), the rising volume of originated mortgages will more than offset the lower interest income.

There is another way for investors to gauge where the consumer side of Wells Fargo’s business is today: by looking into the credit quality levels today compared to the historical cycle for the bank. The primary metric for investors to look over is net charge-offs, meaning the number of loans (whether a mortgage or credit card) considered delinquent today.

This metric is now worth $1.3 billion, up almost 100% from a year prior, when this gauge stood at only $764 million. More than that, the bank has had to tie away more capital into provisions for further (potential) credit losses, which are now $1.2 billion.

The bank also reports lower revenues across most consumer products. Home lending revenues are 3% lower, with credit card revenues matching this decline. The hit was even worse for auto loans, probably due to the rise in vehicle prices and the interest rates charged on auto loans today. That segment declined by 25% in the year.

Optimism Remains High for the Future of Wells Fargo Stock

However, despite how risky the present – and arguably the future – may look for Wells Fargo’s businesses, those on Wall Street still see the upside potential on a cycle turnaround. Analysts at Evercore felt comfortable slapping a $70 price target for Wells Fargo stock, daring it to rally by 24.5% from where it trades today.

Despite the intricacies of the consumer cycle today, the bearish side of the market is showing signs of capitulation. Wells Fargo stock’s short interest plummeted by 20.9% during the past month alone, showing that bearish traders aren’t willing to risk their capital on the potential upswing in the consumer cycle.

The rise in credit delinquencies shouldn’t be taken as a dooming factor for Wells Fargo stock, as other banks like Citigroup Inc. NYSE: C and J.P. Morgan Chase & Co. NYSE: JPM also reported rising delinquency rates and charge-offs. So, this isn’t a company-specific issue but rather an industry-wide problem.

Isolating that trend from Wells Fargo’s business, investors can project the turnaround in credit cards and mortgages to justify Evercore analyst price targets today. The Mortgage Bankers Association (MBA) mortgage purchase index now shows another leg for investors to lean on.

The index reading of 144.3 shows the lowest level since the aftermath of the 2008 financial crisis, meaning that it is more likely than not that the cycle will bring a new wave of upside mortgage applications, which is good for Wells Fargo’s mortgage origination business.