Over the past several weeks the stock market, broadly speaking, has seen the summer rally stall, as lack of continued progress in Europe weighs on sentiment. However, bank stocks is one sector that has continued to perform well despite the market pausing. And as we enter earnings season, banks' relative outperformance is worth noting.
I think a lot of investors are so used to hating bank stocks that they don't think about their earning potential the way they did pre-crisis. But with earnings from major banks coming into focus this week, as a contrarian investor I want to point out three events that are actually positives for the banks.
First, the Housing Market Is Recovering
Not only are prices rising, but also the rental market is strong. That's an important positive because between the price increases cutting losses on foreclosures and the ability for banks to rent properties they can't sell, the case can be made that banks books' values are improving.
And concern regarding their "books" has long been a drag on the sector, which as a whole is cheap on a Price/Book ratio.
Second, Europe Is Less of a Concern
The potential for a sovereign default from Europe has been substantially reduced because of the ECB's latest invention — the OMT — to save the euro. I don't think investors are considering what a drag the prospects of a sovereign default and another financial crisis was on the banks.
It was a structural overhang that depressed valuations and investor's desire to allocate to the sector.
Third, Loan Demand Is Increasing
Although the U.S. economy is still stuck mostly in neutral, there are positive signs for the banks from an economics standpoint: Consumer Credit and Commercial and Industrial Loans are two "foundational" economic indicators I follow. I call them foundational because if they are improving, then that improvement filters through to all the other, more popular economic indicators people follow.
Revolving Consumer Credit is the number to watch because it contains credit card debt and other consumer oriented debt. As you can see in the chart below, it increased 4 percent in August, its first increase in three months.
Click the chart for a larger view.
And Consumer and Industrial Loans have now reached levels not seen since May of ‘09, completing a big recovery. Both of these metrics are positive for banks because it implies more consumer and business demand for loans from banks.
Why it isn't a 100 Percent
The economy isn't in danger of imploding at this point and is actually showing some signs of bottoming. The main overhang on banks remains regulatory. Between unknown regulation from Dodd-Frank and potential paralysis around the Fiscal Cliff, I don't think the coast is totally clear in the banking sector.
But like housing, there are few sectors of the market where you can make the case there are so many bullish factors turning in its favor, while valuations remain reasonable.
Bank TARP Warrants remain, in my opinion, the #1 way to play banks over the long term. These contrarian investments are not stocks, bonds, options, or preferred shares. In fact, they were never even meant to be sold to the public. They are government bailout contracts. And you can use them to get the perfect combination of advantages between stocks ownership and options contracts.
(Editor's note: Tom released a special TARP report late last year, "Government Bailout Contracts: THE Contrarian Investment for 2012." Based on Friday's close, his picks are up as much as 59.56 percent. And additional profits are sure to come! To learn more about these little-known investments and how you can get your hands on Tom's in-depth research with his latest recos, click here.)
However, if you prefer greater diversification, you might consider the KBW Bank ETF (KBE). This exchange traded fund remains one of the more broad-based ETFs that should rise if banks return to historical levels of profitability.
Banks have been market dogs for going on five years now, since the onset of the financial crisis in 2007. But as a contrarian I look for "green shoots" in beaten down sectors. And the way I see it, while the coast isn't totally clear, there are some positive signs occurring in the banking industry.
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