Wells Fargo Poised to Breakout

Since 2008, the media’s scrutiny of the financial sector has intensified significantly. This has thrust many of the larger banks into the spotlight to address issues such as Libor manipulation (Barclays), whale sized trading losses (JPMorgan Chase), and irresponsible underwriting (Morgan Stanley). Undeniably, the whole industry has suffered due to the negative media attention over the last four years despite reducing risk and improving balance sheets across the board.

One bank, however, has used the turbulent wake left over from 2008 as an opportunity. Wells Fargo & Co (WFC) has not only avoided costly blunders but also responsibly increased its market share and is now uniquely positioned to take advantage of any bones the tepid economic recovery might throw.

Wells Fargo is distinct from its more aggressive peers (e.g. GS, JPM, C, BAC) because of its more traditional banking business plan. For starters, the firm has generally avoided complicated derivatives. Nearly a quarter of the firm’s business is mortgage based. As the number one home mortgage lender in the United States, Wells Fargo has the opportunity to capture enormous gains as the housing market continues to revive. In July, the monthly index from the National Association of Home Builders rose to 35, standing at its highest levels since 2007. This substantiates Wells Fargo CEO John Stumpf’s observation that while there has been an uneven economic recovery, the firm has also seen stabilization in the housing market.

In its Q2 earnings report Wells Fargo (WFC) posted record net income of $4.6 billion and beat, albeit narrowly, earnings estimates by posting earnings per share of $ .82 vs. the consensus estimate of $ .81 per share. All of this bodes well for a firm that has seen its peers’ earnings, stock prices, and reputations beaten down over Q2. Indeed, Wells Fargo has seen a 24.11% YTD ROI while the financial sector (as measured by the XLF ETF) as a whole has only seen an 11.6% YTD ROI.
Since 2/3/2012 Wells Fargo has been range bound, trading between $29.80 and $34.80 (its 52 week high). It has tested its resistance level frequently despite the macroeconomic headwinds the markets face on a daily basis. And while this has provided a terrific window to repeatedly ride WFC up to its resistance and back down to its support level, we feel that as we move out of Q3 and into Q4 we will see a significant range expansion to the upside. Not only should the market gain momentum as questions are answered regarding the U.S. presidential election, the European debt crisis will have edged closer to a clear resolution. And while neither of these macroeconomic factors directly affect Wells Fargo’s bottom line, the firm will benefit from the improved market sentiment as uncertainty in the market is reduced.

Upon improved market sentiment, the equity market will see a more risk on sentiment and Wells Fargo’s price action should capture increased alpha as both its technicals and fundamentals strongly suggest a price run up similar to what we saw from December 2011 through mid March 2012. Year to date Wells Fargo has produced impressive return on investment despite the current economic conditions. With improved macro conditions and market sentiment, a price target of $45 by Q2 of 2013 is certainly within reason.