Wells Fargo (NYSE:WFC) delivered a “disappointing” Q2 card, but the market rejected further selling downside as it closed in (last traded at $43.90) on our pre-earnings Buy thesis with a near-term price target of $44. Therefore, our thesis on WFC has played out accordingly, despite the seemingly worsening macro headwinds (remember, the market always looks forward).
We urge investors to look ahead, as we believe the market has likely priced in significant headwinds affecting its massive mortgage business. Therefore, the post-earnings surge wasn’t surprising to us, despite the negative media headlines.
Notwithstanding, we also noted that the market had de-rated WFC, despite expecting a recovery in its EPS through FY24. Therefore, we believe it’s critical for investors to consider how the market intends to value WFC in the current environment to determine a reasonable valuation for WFC moving forward.
Our price action analysis suggests that WFC seems overbought in our short- and medium-term charts. Therefore, we believe a retracement could follow. WFC is also closing in on its near-term resistance ($46), which was rejected by robust selling pressure in May. Therefore, we encourage investors to be cautious about adding at the current levels.
Accordingly, we revise our rating on WFC from Buy to Hold. We encourage investors to bide their time and wait for a meaningful retracement first to assess its support zones.
What To Expect After Earnings?
The media was disappointed with the bank’s earnings as the WSJ reported: “Market downturn weighs on Wells Fargo Profit.” It also highlighted the downbeat tone from management on the impact of macro headwinds, particularly in the origination momentum (down 36%) of its mortgage business. CFO Mike Santomassimo also accentuated (edited):
The mortgage market is expected to remain challenging in the near term, and it’s possible that we have a further decline in mortgage banking revenue in the third quarter. (Wells Fargo Q2 earnings call)
Notwithstanding, the bank remains confident that it can continue to leverage rising interest rates to compensate for weakness in other segments, as CEO Charles Scarf highlighted (edited):
Looking ahead, our results should continue to benefit from the rising interest rate environment, with growth in net interest income expected to more than offset any further near-term pressure on noninterest income. – Barron’s
The consensus estimates (bullish) suggest that Wells Fargo should recover its adjusted EPS growth cadence markedly from FY23 as it laps FY21’s challenging comps (also attributed to its massive reserve release). Therefore, we believe the post-earnings strength seen in WFC corroborates our observation that the market has likely looked past its current headwinds.
Accordingly, we believe investors can look forward to better times ahead, as its EPS growth momentum is projected to reach a nadir in Q2.
Is Wells Fargo Stock Predicted To Go Up?
As seen above, WFC has surged markedly from its June and July lows as the market disregarded its weak Q2 card. We believe the market’s reaction suggests it has already anticipated such weakness, given the battering from its highs in February 2022.
However, as WFC closes in on its near-term resistance of $46, we urge some caution, as WFC could likely come under significant selling pressure at that level.
Notwithstanding, we observed that WFC outperformed its broad financial peers in the Financials ETF (XLF) YTD, as seen above. Notably, WFC posted YTD returns of -9.05%, well ahead of the XLF’s YTD return of -15.66%.
We also observed the outperformance on the WFC/XLF’s medium-term chart. Notably, the outperformance has continued to gain cadence since WFC/XLF reached its bottom in November 2020.
Furthermore, the market also seems supportive of denying further downside, as seen in the April and June 2022 lows. While they don’t constitute bear trap price structures, we observed robust rejection of selling pressure as buyers rushed in to support the lows, overcoming the bears resolutely.
Therefore, it appears the long-term underperformance of WFC against the XLF could be a thing of the past if it can keep up its buying support.
Some investors could argue that our caution at the current levels is unjustified, as WFC remains well below its average valuation levels.
As seen above, WFC last traded at an NTM normalized P/E of 8.89x. It’s still well below its 5Y mean of 12.63x, despite the remarkable recovery from its June lows. Also, given the recovery cadence in its EPS trend moving ahead, it last traded at an FY24 normalized P/E of 7.4x, bringing it even closer to its COVID lows of 6.65x.
Notwithstanding, we would like to highlight that we believe the market has de-rated WFC resoundingly. Note that the market formed a decisive bull trap (indicating the market rejected further buying upside resolutely) in February 2022, as it traded at an FY24 P/E of close to 10x (below its 5Y mean).
Therefore, we urge investors to lower their valuation benchmark by using the price structures as a basis to assess the current valuation dynamics.
Is WFC Stock A Buy, Sell, Or Hold?
We revise our rating on WFC from Buy to Hold.
We believe investors should remain nimble with WFC, given its long-term underperformance against its peers. However, our analysis of the WFC/XLF trend suggests that the underperformance thesis has weakened considerably since its bottom in November 2020.
We also believe that the market has de-rated WFC decisively, even though it seems relatively cheap now. Coupled with its short- and medium-term overbought technical levels, we urge investors to be cautious about adding at the current levels.
Instead, investors should be patient and wait for another retracement to assess the resilience of the buying support before adding.