Thank Vladimir Putin For This Week's Bank Of America Gains

Mar. 8.14 | About: Bank of (BAC)


Market shock on Russia's incursion into the Ukraine set a flight to quality in motion.

The yield curve steepened.

Bank stocks outperformed the market on the important factor to their profits.

Bank of America (NYSE:BAC) was up 4.8% on the week ended March 7th, a period mostly devoid of especially good economic news or a notable corporate event. However, there was an important change that occurred this past week in the financial marketplace which I believe drove gains across the big banks, and that was a steepening yield curve. I believe the change was driven by the beating of war drums in the Ukraine. Thus, BofA investors could very possibly have Vladimir Putin to thank for their meteoric rise. Have faith though, because I don't expect BAC shareholders will need any deals with devils to go even higher.

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5-Day Chart at Yahoo Finance

First some background

Earlier this year, I named Bank of America as my best bet in the real estate relative sector, where I placed it due to its importance in housing finance. The stock entered the year in a unique position versus many other real estate relative ideas; namely, it was still dirt cheap. That's because the bank nearly disappeared during the financial crisis after swallowing up Countrywide and Merrill Lynch at precisely the wrong moment in time. Each seemed like bargains, but Countrywide has been more of a poison potion to the bank than a blessing, so far anyway. Most of BofA's legal issues are related to Countrywide's participation in the illegitimate housing boom of the last decade. As a result, the stock has been trading at a discount to peers on a price-to-tangible book value basis. Only Citigroup is cheaper, and it also bore a great deal of the blame in the real estate collapse and the financial crisis.

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More recently, I've encouraged readers to buy Bank of America on every housing induced dip. The data has been mostly bad, save last week's reported New Home Sales surge. New home sales are significantly less important a measure of real estate than the much larger existing home market, which unfortunately soured at last check. This winter's extraordinary cold and snowy onslaught upon North America has rightfully caught some of the blame for a slowed economy. However, I expect the spring to offer a special bounce back for real estate enthusiasts and related stocks. But Bank of America is much bigger than just mortgage finance, and sometimes is overly sold when bad news surfaces around the housing sector.

I see the improving economy generally and the stock's deep valuation discount playing important roles in the outperformance I expect for it this year. Analysts have been expecting interest rates to rise as the economy grows. The Federal Reserve decision to begin tapering its asset purchases has also offered catalyst for rates, because the synthetic demand it has been creating for mortgage backed securities and treasuries raises their price and anchors mortgage rates and interest rates generally. Inflation has been apparently nonexistent, but I'll have something controversial to say about that subject soon, so stay tuned. Interest rates have been moving higher since the market began anticipating the Fed would start to pull back on its dovish policies.

Something special happened this week though, or rather at the end of last week. When Vladimir Putin's Russia witnessed the revolution in Kiev and acted to guard its military assets (in my opinion) in Crimea, interest rates started higher. The market shock caused by the geopolitical catalyst of Russian feet on the ground in the Ukraine, however unofficial that may be according to the Russians, started a flight to quality in securities markets. Since stocks have held up, some would argue a flight to quality has not occurred, but I think the evidence is clear that demand has picked up for treasuries. 10-Year Treasury yields had moved 14 basis points higher just from Monday through Thursday of this past week. In any event, I see the geopolitical situation deteriorating, and so an eventual full flight to quality is coming in my view.

During a flight to quality, capital rushes for safe havens, and those typically include precious metals and relative securities like the SPDR Gold Trust (NYSEARCA:GLD) and U.S. Treasuries. It's the reason I suggested investors buy gold over the last weekend. Increased demand for U.S. Treasuries puts downward pressure on short-term rates, and it can be a driver of downward pressure on long-term rates as well. In this case, though, the market does not seem to have a taste for long-duration debt instruments, likely because of the long-term risk of rising rates and thereby falling prices for those instruments. Why take on the extra risk anyway?

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This shift in the yield curve does wonders for bank earnings. Bank of America stands to benefit perhaps more than most, thanks to its valuation discount and sensitivity to long-term lending through its mortgage business. This is the reason I believe the bank is up so much this past week, and that has everything to do with the Putin driven flight to quality in my view.

Concluding, what many do not know about BofA is that it also benefits from a pickup in short-term rates (see Nancy Bush's questions in the last conference call transcript). While that is not occurring today thanks to Putin, when it eventually does, the company estimates a 100 basis point increase translates into approximately $3 billion in net interest income. For that, we'll turn to Janet Yellen and the American consumer for attribution. Thus, while this week's gains were fantastic, we will not be needing any deals with devils to go even higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.