Mega-cap banks poised to extend recent momentum

U.S. banks have been driven by a number of factors for about the past year, and Fidelity Portfolio Manager Matt Fruhan believes the backdrop will remain particularly favorable for some of the industry’s largest institutions.

“I think it’s going to be a three- or four-horse race, with the largest banks galloping away from the rest of the pack and taking organic market share for the next 10 to 20 years,” says Fruhan, who manages Fidelity^® Mega Cap Stock Fund (FGRTX). “I see this as one of the best organic share-taking stories in the stock market.”

In helming the fund since 2013, Fruhan prefers stocks that the market has mispriced due to investors’ overreactions to changes in short-term earnings estimates. He believes that by combining deep investment research with patience and discipline, an investor can take advantage of these pricing inefficiencies.

This has led to banks representing 12% of the fund’s assets as of May 31, a significant overweight versus the benchmark. Fruhan says he is confident in this stance, even while acknowledging that the strong recent run for banks may be in the homestretch.

“I still see potential in the banking industry, especially among some mega-cap banks,” he explains. His favorable outlook is partly based on his view that the market has become more confident in the security of bank deposits following last year’s turmoil among regional banks. This has recalibrated investors’ views on the potential downside of investing in the industry, he adds.

While the timing of such a move is debatable, Fruhan does note that a U.S. Federal Reserve interest rate cut likely would boost banks’ net interest margin with the current yield-curve configuration and diminish worries about their credit-related losses in the commercial real estate industry.

Fruhan notes that proposed regulatory changes to heighten capital requirements for banks could further work to the benefit of the largest banks. He explains that when regulators install more-stringent capital rules for the biggest players, it strengthens them financially and makes them an attractive destination for deposits in times of stress.

“Another important benefit for big financial institutions is the disproportionate benefit they may realize from artificial intelligence,” says Fruhan. He believes that their deep pockets will allow them to meaningfully invest in AI technology, while other, smaller institutions will not be able to come close to matching that spending.

At the end of May, Wells Fargo (WFC) and Bank of America (BAC) were among the fund’s largest holdings and overweights, while JPMorgan Chase (JPM), the world’s largest bank, was a smaller but meaningful position.

Fruhan’s bullish view of Wells Fargo, which he says in recent years faced significant financial and management challenges, is partly based on a fairly new leadership team that has been turning around its business, successfully reducing costs and improving capital allocation.

Looking ahead, Fruhan is keeping a close eye on Wells Fargo and other banking stocks. “I think we’re getting closer to a decision point,” Fruhan concludes. “If the fund’s bank holdings keep going up, I’d expect to tactically reduce some position sizes, as the risk-reward trade-off begins favoring other opportunities. Long term, however, the organic market-share-gain story is a powerful investment thesis.”

For specific fund information, including full holdings, please click on the fund trading symbol above.