Bank stocks have been the darlings of this latest market rally. Hardly a day — or even an hour — goes by without some fund manager on CNBC repeating the “buy financials†mantra.
Is it some weird cult thing? Maybe everyone on Wall Street should start wearing gray jumpsuits and perfectly white sneakers … because it sure seems like all these so-called experts have had too much of the “crazy†Kool-Aid.
Their sacred text goes something like this: “The Fed is just about to cut interest rates and inflation is dead, so buy bank stocks.â€
Like many misguided theories, the logic is sound, but the premises are way off base …
The Fed Is Not
Cutting Rates!
All we’ve heard from Wall Street’s high priests and priestesses is that the Fed is going to swoop in and give financial stocks a boost with a few well-timed interest rate cuts. Fund managers can’t wait for more monetary manna from heaven.
But the Fed is practically tripping all over itself to warn bond traders that rate cuts are NOT looming. You can read more about some of the Fed’s past comments in my article, “Bond Market Fighting the Fed.â€
And this week, we got a behind-the-scenes peek into the September meeting of the Fed’s 12 regional banks. Turns out that two banks — Dallas and Richmond — actually wanted to HIKE the discount rate in September. According to the minutes:
“The recent moderation of economic growth, which resulted largely from the slowdown in the housing sector, and the recent decline in energy prices were seen as unlikely to lead to a significant reduction in inflation pressures.â€
By the way, it’s not just the Fed indicating that rate cuts aren’t coming. I won’t bore you with all the nitty-gritty, but I watch a type of investment called Eurodollars. Suffice it to say that Eurodollars RISE in price when rate CUTS are looming, and they FALL when rate HIKES are more likely.
What’s happening right now? Prices have tanked in the past several days, breaching a multi-month uptrend on the charts. The fact that these investments are declining is yet another indication that the Kool-Aid crowd has it all wrong. 
Now, what about the second part of their argument?
Inflation Is Not
Dead and Buried …
We just got the latest batch of inflation news out of Washington. One juicy tidbit: The core Producer Price Index, which excludes food and energy costs, surged 0.6% in September. That was three times the market forecast.
Even though a chunk of the PPI gain came from a statistical glitch in wholesale car and truck prices, there was plenty of inflation pressure evident elsewhere, too.
As for the Consumer Price Index? No relief there. The core CPI jumped another 0.24% in September. That pushed the year-over-year change in core consumer inflation to 2.9% from 2.8% in August. Core prices haven’t risen this much in ANY month going all the way back to January 1996.
Another thing: Lower energy prices have been keeping the so-called “headline†inflation numbers, the broadest measures of inflation, somewhat in check recently. But natural gas prices are already starting to rise as temperatures fall and OPEC is cutting crude oil production. So energy costs may soon start rising again.
Add it all up and there goes the “buy bank stocks†cult’s second precept. Here’s the final nail in the coffin …
A Lot of Banks Have Been
Reporting Weak Earnings
Shares of JPMorgan Chase (JPM) have been on a tear recently. Reason: Investors have assumed that its business was firing on all cylinders. If that’s the case, it sure didn’t show in the company’s third-quarter earnings results:
- Consumer bank revenue actually fell 1%.
- Credit card revenue slumped 8%.
- Fixed income trading revenue dropped 3%.
- Equity trading revenue fell 14%.
- And mortgage revenue was off a whopping 49%!
It’s not just JPM, either. Banking behemoth Wachovia (WB) posted earnings that weren’t much to write home about. Ditto for SunTrust (STI). And Washington Mutual (WM)? Its results were awful!
The mega-thrift’s third-quarter profit dropped almost 9%.
Earnings from continuing operations were just $0.84 a share, well below Wall Street’s $0.93 estimate.
The company’s home mortgage lending arm went from earning $302 million a year ago to losing $33 million.
Am I saying that all financial stocks are bad? No. In fact, there are a few select, conservative banks out there that I really like (I talked about one in the latest issue of Safe Money Report). One particularly promising bunch: Foreign institutions with exposure to booming countries like China and India.
But I’d be extremely wary of banks that have taken major credit risks … banks that are hip-deep in derivatives … and banks that are too exposed to the mortgage sector.
In short, the next time you hear the siren song of “buy financials†over the airwaves, remember — not all banks are created equal. Buying the wrong one is like tossing your money into a Waco inferno.
Until next time …
Mike
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