Financial stocks banks, brokers, asset managers led the stock market down earlier this year, and almost left the stage as many shares sank into single digits. In recent weeks, however, the group has reversed course, rallying strongly, and even led the market to a robust gain on Monday, with the Dow rising 235 points. So is this the sign of a true financial-stock recovery, or a seductive bear trap? TIME contributing editor John Curran caught up with Oppenheimer & Co. chief investment strategist Brian Belski, who was in Tel Aviv on Monday, to get his view on banks.
Banks are still full of bad news. Why are the stocks showing such strength?
We've seen unprecedented liquidity being put to work in the U.S. on behalf of financials, so it was only going to be a matter of time before banks started to rise. Also, many investors have been so focused on the short term all the recent steps taken by the Federal Reserve and the Treasury that they have forgotten that the bank assist started in August of 2007 when the Fed cut the discount rate and opened the lending window to a wider list of financial companies. So this has been going on for a little less than two years. Typically when you see that type of extended intervention, and such an enormous amount of money being thrown at the problem, it's only a matter of time before some positive things occur. (See 25 people to blame for the financial crisis.)
Is this a sigh-of-relief rally, or is something positive going on with respect to the longer-term earnings potential of financials?
I don't think this rally has much to do with the longer-term earnings potential of these companies. I think the move in financials, mostly over the last four to six weeks, is primarily a sigh of relief. To be more precise, it's about institutional investors repositioning themselves in these stocks. Last year there was a mass exodus from financial stocks, and not just the banks. There was just too much risk, and it was too difficult to navigate through the financial sector to find stocks that didn't have subprime risk or related issues. Even the asset managers got hit by withdrawals and redemptions.
This year, financial-sector earnings probably troughed in the first quarter, so the risk becomes don't be too underweight. It takes a huge swing to go from not owning any financial stocks to being market weight in financial stocks. Big investors are scrambling to catch up. (Read "The Outlook for Stocks is Decidedly ... Mixed.")
How much catching up still has to happen?
Look at it this way: at the financial-stock peak they were around 27% or 28% of the S&P 500's total market capitalization; the financial sector got down to 9% at their low. Now they are about 12%. I believe the financial sector will rise back to 13% to 15%, which means the portfolio-readjustment buying isn't finished. But take note, the sector has had very big moves recently, and not all banks will be able to hang on for the next leg of this.
Which banks will show strongest performance?
It depends upon your time horizon. If you are looking for the next three to five years we would be looking at those that have management transparency and credibility, and where management has been able to deliver results. Now there is also what we'll call a "beta trade" in banks these are the lower-quality banks that have been beaten up the worst, the ones people have more fundamental questions about, whether they will be broken up or will fail. Everything is rallying at the moment, but we would much rather be in the former group, the long-term plays in leadership banks. I'm talking about such companies as Goldman Sachs, JPMorgan Chase, Visa, US Bancorp and Wells Fargo.
What's the biggest risk to a continued rise in bank stocks?
There are three risks: first, that credit spreads widen again and go back up to historic highs; second, that the employment situation, on a relative basis, is not improving and we see an acceleration in the rate of weekly jobless claims; third, if housing takes another big move to the downside.
So financials may have a couple more months of relative strength as portfolios readjust, but when might banks and brokers reemerge as stock-market leaders?
Before financials can emerge in a leadership position we will need to see some semblance of very stern regulation in the financial field, which will signal to investors that financial companies are clean at that point they may even be overregulated. Also, between 2001 and 2007 financials added a bunch of capacity, and that needs to recede, through consolidation or simply going out of business. That's still a few years off.