Bank stocks are providing excellent leadership this year. In fact, if it weren’t for the credit crisis that surfaced in 2008, financial institutions, such as banks, credit, and insurance companies may still be playing Russian roulette on their balance sheet as far as risk.
It now appears that bank stocks are cutting down on the amount of risk that they are willing to take on. The Goldman Sachs Group, Inc. (NYSE/GS) is now at a point where the potential loss that can occur from trading is at a seven-year low. The other major Wall Street banks are also seeing a reduction in their risk. (Source: LaCapra, L.T., “Goldman trims risk-taking to lowest level in 7 years,” Reuters, March 1, 2013.)
The major bank stocks all closed 2012 near their respective 52-week highs and have started 2013 with a bang, with the KBW Bank Index up 5.8%, slightly below the comparative return of the S&P 500 and the Dow, but above the NASDAQ. The attraction to the bank stocks has been driven by an improving banking industry that is assuming less risky businesses while shoring up their balance sheets and producing stronger units.
The chart of the Philadelphia Bank Index below shows the upward move of bank stocks from their 2011 bottom. Bank stocks staged a nice rally but retrenched in March to May 2012 on the European bank concerns, and Moody’s Investor Services downgraded the sector. The group has since staged a rally back above the 50- and 200-day moving averages (MAs). But there was some topping on the charts, followed by the recent selling, as indicated by the blue circle on the chart.
Chart courtesy of www.StockCharts.com
There is now market speculation that the rally in bank stocks has come to a halt; but I feel there will be more gains ahead, and I look at banks as a contrarian investment at this stage. Of course, if the economy tanks, it will have an impact on banks, but for the time being, profits at these banks continue to edge higher on improving revenue growth.
The reality is that the “Volcker Rule,” set in place by economist and ex-Federal Reserve Chairman Paul Volcker, appears to have worked to cap the speculative trades and risk that banks are able to assume. Banks have altered the way they do business and have shown positive strides.
In my view, the operating results have been fairly good, and they indicate that the banks are able to grow their business volume across the board during an economic recovery in the U.S.
In a few days, on March 7, the results of the 2013 stress test on the major bank stocks with over $50.0 billion in assets will be released by the Federal Reserve. The banks will be tested based on a worst-case scenario to see the impact on the banks and their ability to handle a major financial crisis. The key assumptions include the unemployment rate surging to 12%, a recession in Japan and Europe, and the economy weakening in China. In the 2012 stress test, 15 of the 19 U.S. big bank stocks passed the stress test, as compared to 2009, when half of the big banks failed.
Should the stress test show better results, we could see a lift to the banking sector and not a downturn, as some market watchers feel could happen. In the best-case scenario, banks will be allowed to raise their dividends back to the two-percent-plus level. If this should occur, we could see a corresponding rise in the demand for bank stocks.