Listening to volatility
04/13/18
If it weren’t for Facebook’s (FB) recent travails, Wells Fargo (WFC) might still be the poster child for stocks attempting to rebound from public relations disasters. In 2016 news broke that WFC employees had been opening millions of unauthorized accounts and products for their customers in order to meet sales targets and generate fees.1 It seemed like an unprecedented breach of trust in the banking world.
Wells Fargo (WFC) 10/24/11–4/12/18. WFC weekly price chart. New highs amid turmoil

Source: OptionsHouse

The market’s judgement was swift and merciless. Okay, not really. In fact, the weekly chart above shows that while WFC dropped sharply in September 2016 when the story broke, the stock had already been trending lower since July 2015, and the down move merely brought prices slightly below the February and June lows (around $44.50) before shares exploded to the upside on the heels of the 2016 presidential election.

Since then, WFC has banged out a couple more record highs, in February 2017 and January 2018, before the most recent downswings took shares back into a general support zone between approximately $41.50 - $51.50.

The overall bullishness in 2017 was not a matter of WFC having put the scandal behind it. On the contrary, the stock’s choppy road higher from November 2016 to this January occurred as the company was still trying to fix problems, pay fines, and engage in damage control—all the while with the threat of government handcuffs hanging over its head.

The down gap on February 2-5 marks the spot where the Fed finally dropped the hammer on WFC. Among the steps it took was to restrict the bank from growing its asset base beyond its end-of-2017 level until “the firm makes sufficient improvements[.]” The Fed’s measures were seen by many at the time as extraordinary.2

This time the market’s judgement was swift and merciless, and the stock (in the midst of the February broad-market correction) dropped 16% over the course of six days before rebounding and then extending its peak-to-trough loss to around 22% by late March (see daily chart below).

Wells Fargo (WFC) 10/16/17–4/12/18. WFC daily price chart. Price-volatility disconnect

Source: OptionsHouse

This chart, however, reveals something interesting about WFC’s February and March lows. The bottom portion of the chart shows the implied volatility (IV) of WFC options, and highlights the fact that when the stock made a much lower low in late March, IV made a slightly lower high. Similar to the inverse relationship between the S&P 500 (SPX) and the CBOE Volatility Index (VIX), a lower price low would normally be accompanied by a higher IV high.

In this case, WFC dropped below its February correction low to its lowest level in eight months, and IV failed to its previous level—a possible sign that the market felt all the “bad news” was priced in (or at least the stock was temporarily oversold), which can sometimes lead to a bounce or rally. The stock has since moved mostly sideways, while remaining above its April 2 low, with Q1 earnings scheduled for today’s pre-market.

It's also worth noting that even after the Fed penalties were announced, some investment banks lowered their targets for WFC (to the $70s), but maintained their buy ratings on the stock.3 Meanwhile, WFC uber-stakeholder Warren Buffet reiterated his confidence in the bank,4 although he can hardly be called a dispassionate observer.

After the earnings-number dust settles, WFC’s picture may be a little clearer, especially if the bad news really is in the rear-view mirror and the market continues to stabilize.

 

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1 CNN.com. Wells Fargo's 17-month nightmare. 2/5/18.

2 The New York Times. Federal Reserve Shackles Wells Fargo After Fraud Scandal. 4/11/18.

3 StreetInsider. Wells Fargo (WFC): Cutting Estimates On Consent Order But Impact Is Manageable - Goldman Sachs; and Wells Fargo (WFC): Cutting Estimates Slightly On Consent Order – Nomura. 2/5/18.

4 US News & World Report. Warren Buffett Still Has Confidence in Wells Fargo. 2/27/18.