Noah Sauve/iStock Editorial via Getty Images

Noah Sauve/iStock Editorial via Getty Images

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.

Wells Fargo adjusted EPS change % consensus estimates (S&P Cap IQ)

Wells Fargo adjusted EPS change % consensus estimates (S&P Cap IQ)

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.

WFC price chart (weekly) (TradingView)

WFC price chart (weekly) (TradingView)

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%.

WFC/XLF price chart (weekly) (TradingView)

WFC/XLF price chart (weekly) (TradingView)

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.

WFC normalized P/E trend (S&P Cap IQ)

WFC normalized P/E trend (S&P Cap IQ)

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.

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.

We help you to pick lower-risk entry points, ensuring you are able to capitalize on them with a higher probability of success and profit on their next wave up. Your membership also includes:

24/7 access to our model portfolios

Daily Tactical Market Analysis to sharpen your market awareness and avoid the emotional rollercoaster

Access to all our top stocks and earnings ideas

Access to all our charts with specific entry points

Real-time buy/sell/hedge alerts

Sign up now for a Risk-Free 14-Day free trial!

This article was written by

I'm Jere Wang, the lead writer and founder of JR Research and Ultimate Growth Investing Marketplace service. Our team is committed to bringing more clarity to investors in their investment decisions.

Our marketplace service focuses on a price-action-based approach to growth and technology stocks, supported by fundamental analysis. In addition, our general SA site discusses stocks from various sectors and industries. 

Our discussion mainly focuses on a short- to medium-term thesis. While we hold stocks for the long-term, we also use appropriate opportunities to benefit from short- to medium-term swings, leveraging long (directionally bullish) or short (directionally bearish) set-ups. 

My LinkedIn: www.linkedin.com/in/seekjo

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.