Is Bank of America Stock a Buy Before the End of 2017?

John Maxfield, The Motley Fool

If you have an interest in bank stocks, then you've probably thought a time or two about Bank of America (NYSE: BAC). The nation's second-biggest bank is one of the most widely held bank stocks in the country, and it has also been one of the best-performing stocks in the industry over the past few years.

Does this mean that investors should rush to add Bank of America stock to their portfolio before 2017 ends? From a fundamental perspective, I would argue that the answer to this is yes, as the Charlotte, North Carolina-based bank has seen its efficiency and profitability improve consistently over the past two years in particular. At the same time, however, investors need to be cognizant of the broader market right now.

What I mean is that stocks in general are trading at a very high valuation. If you look at the valuation index created by Yale economist Robert Shiller, large-cap stocks have only traded at a higher valuation twice in the past. The first time was in 1929, just before the market crash that ignited the Great Depression. And the second time was in 1999, at the peak of the dot-com bubble.

A line chart tracking the Case-Shiller P/E ratio.

Data source: Robert Shiller. Chart by author.

Further complicating things is the fact that investors appear to be eerily complacent right now. An absence of activity and volatility in the fixed-income markets (bonds, currencies, commodities, etc.) has caused trading revenues at universal banks like Bank of America, JPMorgan Chase (NYSE: JPM), and Goldman Sachs (NYSE: GS) to contract.

At JPMorgan Chase, third-quarter revenue from its fixed-income trading operations was 27% below the same quarter last year. Goldman Sachs saw a 26% drop. The decline at Bank of America wasn't as sharp, but it was still significant, with fixed-income trading revenue falling by 22% in the three months ended Sept. 30 compared to the year-ago quarter.

There is a similar sense of complacency in the equity markets. You can see this by looking at the S&P Volatility Index (VOLATILITYINDICES: ^VIX), or VIX. This tracks expected volatility in the stock market over the next 30 days. It used to be unheard of for the VIX to come in below 10, but that's been closer to the general rule than the exception this year. This means that expected volatility among large-cap stocks like Bank of America, JPMorgan Chase, and Goldman Sachs, among others, is roughly half its long-run average.

A line chart tracking the VIX.

Data source: Yahoo! Finance. Chart by author.

This is unusual given the extreme domestic and international political volatility that only seems to grow with each passing day. It's this lack of consonance between the markets and politics that has some of the world's best investors and highly reputed financiers concerned.

Ray Dalio, the founder and former co-CEO of Bridgewater Associates, one of the world's largest hedge funds with $150 billion in assets under management, wrote in June in a LinkedIn post:

Ordinarily, politics and economics influence each other with economics being more of a driver on politics than politics is on economics -- e.g., bad economic conditions normally lead to political changes -- and normally we don't need to pay much attention to politics to get the economics and markets right. However, there are times when politics becomes the most important driver. History has shown us that these times are when there is great economic, social, and political polarity within a country and there is the selection of populist leaders to fight for "the common man" in a battle against "the elites." These conditions exist now. The 1930s were the last time this happened in the developed world and globally.

Here's what Howard Marks, co-chairman of Oaktree Capital Group (NYSE: OAK), had to say in a memo to clients in July:

[I]t's essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature. I think it's better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses.

Since I'm convinced "they" are at it again -- engaging in willing risk-taking, funding risky deals and creating risky market conditions -- it's time for yet another cautionary memo. Too soon? I hope so; we'd rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains. (We all want there to be bargains, but no one's eager to endure the price declines that create them.) Since we never know when risky behavior will bring on a market correction, I'm going to issue a warning today rather than wait until one is upon us.

The Bank of America Plaza in Dallas, Texas.

The Bank of America Plaza in Dallas, Texas. Image source: Getty Images.

Here's Jeffrey Gundlach, co-founder and CEO of DoubleLine Capital, a fund with $110 billion in assets under management, in a Bloomberg interview in August:

If you're waiting for the catalyst to show itself, you're going to be selling at a lower price. This is not the time period where you say, 'I can buy anything and not worry about the risk of it.' The time to do that was 18 months ago.

And most recently, at the end of October, the head of JPMorgan Chase's investment bank, Daniel Pinto, went on record to say the nation's biggest bank by assets is anticipating a painful market correction in the near future, according to analysts at KBW.

The implication is that there is a significant amount of so-called systemic risk in the market right now. This is the type of risk that goes with owning any stock, not just Bank of America, JPMorgan Chase, or Goldman Sachs. Consequently, despite that fact that Bank of America is almost certain to have a better 2018, maybe even its best year ever, investors would be smart to consider the state of the overall market before making any buying or selling decisions.

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John Maxfield owns shares of Bank of America. The Motley Fool owns shares of and recommends Oaktree Capital. The Motley Fool has a disclosure policy.