Why Bank of America Stock Is Headed Higher


Shares of Bank of America are following the broader market higher today on the heels of better-than-expected data out of the housing sector as well as a lower-than-expected core inflation figure for the month of May. Roughly halfway through the trading session, stock in the nation's second largest bank by assets is up by $0.11, or 0.83%.

The performance of bank shares today belies the fact that the industry is at a crossroads. With the Federal Reserve's quarterly monetary policy meeting scheduled this week, many are speculating that the central bank will begin to taper its support for the economy over the next few months. This will most likely entail a reduction in open-market bond purchases -- it's currently buying $85 billion worth of federally insured securities a month -- and a resulting increase in long-term interest rates. This is invariably good for banks, as it will lead to an expansion of net interest margins across the industry.

Yet, the expected move by the Fed is not without risk. The primary issue concerns what will happen to the housing market -- and specifically, prices -- when the Fed reduces its purchases of agency mortgage-backed securities. There's little doubt that this will drive mortgage rates up, which it already has, as you can see in the chart below. But will this also drive the price of houses, and therefore the value of mortgage collateral, down? Or could it have the opposite effect by freeing up banks to make more purchase-money mortgages as opposed to refinance loans?

US 30 Year Mortgage Rate Chart
US 30 Year Mortgage Rate Chart

US 30 Year Mortgage Rate data by YCharts.

I personally think it will do the latter. Wells Fargo serves as a particularly prescient example, here, because it underwrites roughly one in every three mortgages in the United States. For most of last year, more than 70% of its mortgage applications related to refinancing requests, leaving less than 30% related to purchase-money mortgages. In the most recent quarter, however, this mix shifted, as only 65% of mortgage applications related to refinancing. As the share of purchase-money mortgages increases -- assuming, of course, that the total number of applications doesn't markedly decline -- the housing market should continue to gain momentum.

Whatever may be the case, there's little question that we're currently approaching this critical fork in the road, at which the Fed must decide which path to pursue. And it's for this reason today's data releases are so important. The first, issued by the Bureau of Labor Statistics, showed that core inflation -- that is, consumer prices less food and energy -- rose sequentially by only 0.1% last month compared to the consensus estimate of 0.2%. And the second, issued by the Commerce Department, estimated that new home construction ticked up by 24.9% in April over the same month last year. Critically, however, almost all of the growth in the latter was in multifamily construction, which is notoriously volatile, and not in the more important single-family space.

What does this mean for the Fed? That remains to be seen, but both would seem to indicate that it should not rush into a decision to taper. Either way, however, the market took the news in stride, sending stocks, and particularly those in the financial space, higher, as evidenced by Bank of America's ascent as well as the climb in the KBW Bank Index .

Indeed, Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, Financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.

The article Why Bank of America Stock Is Headed Higher originally appeared on Fool.com.

John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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