This week’s move by the Fed could push big bank stocks much higher

From Justin Brill, Editor, Stansberry Digest:

Is the Fed out of touch?

Last week, the Federal Reserve voted to raise short-term interest rates another 0.25% as expected. The so-called “fed-funds rate” now sits at a range of 1%-1.25%.

In its official statement, the central bank said that it continues to expect to raise rates at least one more time this year. And it said it is moving forward with previously announced plans to unwind its massive $4.5 trillion bond portfolio.

In other words, nothing to see here.

However, there are signs the central bank could be behind the curve…

Price inflation remains below the Fed’s official target of 2%, and appears to be rolling over… Various measures of economic strength like home sales, retail sales, industrial production, and even consumer sentiment have weakened as of late… and the promise of economic reforms out of Washington has faded.

To be fair, in her press conference on Wednesday, Fed Chair Janet Yellen admitted that inflation was weaker than she would like. But she insisted this was “transitory” and that the economy remains strong. As financial-news network CNBC reported at the time…

Fed Chair Janet Yellen is focused more on economic growth than she is inflation weakness, leading her to believe the central bank will keep raising interest rates.

The central bank head addressed perhaps the most vexing issue facing issue facing policymakers, mainly that Fed policies have yet to achieve the 2% inflation target its programs were supposed to generate… Yellen indicated she’s not terribly concerned about the weakening inflation trend.

“Our decision to make another gradual reduction in the amount of policy accommodation reflects the progress the economy has made and is expected to make toward maximum employment and price stability assigned to us by law,” the chair said during her post-FOMC meeting news conference… The recent lower reading on inflation have been driven significantly by what appears to be one-off reductions in certain categories of prices such as wireless telephone services and prescriptions drugs,” she said.

In other words, Yellen believes inflation will resume its recent uptrend soon…

We’re not so certain. Again, much of the recent pickup in economic activity was driven by expectation of reforms out of Washington. If these don’t happen reasonably soon, we expect the economy will fall back into the slow, grinding trend of the past several years.

In that case, the Fed could be forced to halt its tightening cycle – or even begin easing once again. We’ll be keeping a close eye on this trend.

Of course, none of this means the market can’t go higher…

Meanwhile, another Federal Reserve move could be incredibly bullish for one sector in particular…

On Thursday, the Fed is scheduled to release the results of its annual “stress test” for U.S. banks. This test – which was put in place following the financial crisis – is designed to gauge banks’ ability to survive another meltdown.

While the test isn’t expected to uncover any major weaknesses this time around, it could be a boon for investors. As news service Reuters reported this morning…

According to [Wall Street] estimates, the Fed could allow banks to distribute nearly as much capital to shareholders over the next year as they generate in profits, a benchmark not hit since before the 2008 crisis.

Higher payouts “would be significant from a signaling standpoint” that regulators are easing up on capital requirements, said Steven Chubak, a bank analyst at Nomura Instinet. “That is a key part of the value case for a lot of these stocks.”

Said another way, the Fed is expected to give the “all clear” and allow the biggest and best U.S. banks to return much more capital to investors going forward.

How much capital? According to Morgan Stanley analyst Betsy Graseck, the typical “big bank” could be allow to increase share buybacks by 27% and dividends by 8%. Altogether, she expects the combined “capital payout” ratio to be raised to 95% of annual earnings, up from just 84% last year.

If you already own U.S. banks, sit tight…

These results could be a significant tailwind. But if you don’t yet have a position in the sector, our colleague Dr. David “Doc” Eifrig has a suggestion.

In the April issue of his Retirement Millionaire newsletter, Doc recommended one big bank that he says is head and shoulders above all the rest. From the issue…

To a casual observer, the names of the big Wall Street banks tend to run together. The JPMorgans, Goldman Sachs, Morgan Stanleys and so on sound like similar businesses in close competition. They seem pretty much the same.

To anyone watching closely, though, [one bank] dominates the finance industry.

Banks can be a lot of things. They can work with consumers, underwrite public stock offerings, trade for profits, or lend money. Most banks focus on a few key areas and dabble in others. But [this bank] is in the top two or three of nearly every category.

In addition, Doc noted that this bank is consistently among the most profitable in the world…

The main measure of a bank’s profitability is return on equity (ROE). In a simplified sense, this measures how much profits the bank earns from the equity its shareholders have contributed to give the bank a capital base. [This bank] consistently beats the other big banks in posting a healthy ROE.

And most important, Doc explained that the bank isn’t taking big risks to fuel this growth…

[Its] capital ratios fall in line with the industry and have been rising. The company has got a better credit rating from Standard and Poor’s [than any of the other big banks.]

When you look at the cost of insuring [its] bonds, you’d pay less to do so than for any of the other banks. In other words, traders think it’s the safest bank in the market.

In short, if you’re looking to own the safest and most profitable of the big banks, Doc’s recommendation is a no-brainer. Again, you can get all the details in the April issue of Retirement Millionaire. Click here to learn about a 100% risk-free subscription.

Regards,

Justin Brill

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