Charles Schwab (NYSE: SCHW)
is set to report its Q4 earnings tomorrow. The company looks like it will close 2020 with a strong quarter, but 2021 should be even better.
For Schwab, 2020 was a tale of two halves:
In the first half, shares plummeted nearly 30%. But in the second half, shares soared by more than 60%. Shares closed the year up only around 11.5% – you can thank the sequence of returns for that – but it was still a nice comeback.
Schwab has carried its second-half momentum into 2021, with shares closing above $60 for the first time ever this week.
Schwab shares are in overbought territory, but this rally is still in the early stages.
Rising Interest Rates is Good News for Schwab
Schwab’s move to commission-free trades and its TD Ameritrade acquisition made the company more reliant on its net interest margin business, where Schwab loans out its client cash balances at prevailing interest rates. With interest rates so low, this wasn’t a lucrative business in 2020.
But now medium and long-term interest rates are on the rise. 10-year treasuries are now above 1% for the first time since March 2020. That is still historically low, but much higher than their summer range of between .5% and .7%. The Fed hasn’t changed its guidance – it still expects to keep its fed funds rate near zero until at least 2023 – but it can’t completely control the fixed income markets.
Wells Fargo (NYSE: WFC) analyst Christopher Harris thinks that for every 25-basis point increase in long-term rates, Schwab could see its EPS increase by 3%. A 25-basis point increase in the fed funds rate, unlikely as it may be, could boost Schwab’s bottom line by 10%.
So, why have long-term interest rates started to rise? And is this just the beginning?
The Democratic Party is about to take full control of the Federal Government, and they have pledged to spend whatever it takes to jumpstart the economy. That spending could lead to higher growth and inflation. The market is a forward-looking mechanism, so it is pricing in these expectations. Interest rates could stabilize or even head back down – the past decade has taught us that bond yields can always go lower – but rates certainly have more room to go up than down. That asymmetric payoff is favorable for Schwab.
Another asymmetric payoff for Schwab is what the Fed can do. It almost certainly won’t push rates any lower – Fed officials are reluctant to go into negative territory – but if growth starts to pick up, the Fed can change course and raise rates ahead of schedule.
Stimulus Payments = New Traders
In 2020, there was an influx of traders into the market. It may seem like all of them registered with Robinhood, but Schwab picked up a lot of them too. In Schwab’s November Monthly Activity Report, the company said that 430,000 people created new brokerage accounts in November, up 200% yoy.
There are a few reasons why so many people started trading including:
- Stock market at all-time highs.
- Bored people turning to the market to fill their free time.
- Stimulus checks giving people money to trade with.
The stock market has been hitting all-time highs for months and people have been stuck inside for almost a year. So, those tailwinds have been in full-effect for a while.
Stimulus checks are a different matter. Millions of Americans got a $1,200 check last spring, but didn’t get anything for the rest of the year. Now, $600 checks are rolling in. And Democrats are talking about adding another $2,000 in stimulus payments after Joe Biden takes office.
It’s hard to say how much of an impact stimulus checks have on Schwab’s business, but it’s clearly substantial. Millions of Americans are hurting, but most people haven’t lost their jobs – many people in the latter group are treating the stimulus checks like house money.
Assuming the market keeps chugging along, Schwab could see registrations surge in Q1.
How Should You Play Schwab?
Schwab’s Q4 numbers are likely to be solid, but not spectacular. Q1 2021, however, could be spectacular.
The strong possibility that the company discusses Q1 tailwinds or gives good guidance in tomorrow’s release makes Schwab shares appealing today.
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