Last week, Joe Biden announced that he would nominate current US Federal Reserve (Fed) Chair Jay Powell for a second term. His most pressing concern will be to stop the onset of hyperinflation. Inflation, which is the general rise in price levels due to the increase of monetary supply, has taken off in recent months. This can be bad news for us stock investors. Warren Buffett has said there is no greater destroyer of wealth than inflation. Right now the Fed is indicating that in order to curb inflation, which is running in excess of 6%, it will taper its purchases of US treasury securities. This and the increase of interest rates in 2022 are the options available to Powell and his team at the Fed. It remains to be seen how soon and how effective these interventions will be in preventing all-out carnage on investor returns.
There are, however, certain types of businesses that can survive and even do well in this environment. I recently wrote an about a UK stock that I think will do well in this inflationary environment. I believe the following two banking stocks are in that same mould. Why banks? Well, they benefit from higher interest rates because it affords them higher yields on the cash they hold on behalf of customers.
A Buffett-backed banking stock
First up is Bank of America (NYSE: BAC). When Buffett sunk $5bn into this banking stock in 2011, it was a vote of confidence in the leadership of CEO Brian Moynihan and that bet has not let Buffett down. Bank of America has arguably the best consumer banking brand in the US. Its industry-leading wealth management platforms function well with Merrill Lynch and it has made the necessary technology investments to be award-winning in that space. It is one of the ‘Big Three’ US banks, which attract 50% of all new checking accounts. With a current price-to-earnings ratio of 13.86 and a price-to-book ratio of 1.52, I think this banking stock is trading at a discount.
A bank for the ages
Fun fact: US Bancorp (NYSE: USB) operates under the second-longest continuous banking charter in US history and is currently the fifth-largest banking institution in the US. Fun aside, this stock is also a staple in the value matrix of many hedge funds. Its 3.12% dividend yield is attractive to me. With $568bn in assets, this bank is not only large but very efficient. It has trended upward with an average increase of 9% over the past 10 years. As a banking stock, it excels not only due to its size and efficiency but is expanding rapidly. It recently acquired MUFG Union Bank for $8bn and just announced plans to acquire fintech firm Travel Bank.
Banks are of course subject to various systemic risks – the 2008 crisis proved this. And all banks are dependent in part on central banks for their cues. Right now the main threat is that the Fed fails to control inflation. Inflation allows borrowers to pay back lenders with money that is worth less than what they originally borrowed. Inflation in excess of 6%, combined with the Biden administration’s plan to increase the corporate tax rate by at least 5%, could mean a pretty steep hurdle rate for banking investors to make good returns in the future.