Financials Rebounding - 3 Banks Unaffected by Housing Prices

Includes: BK, BNS, JPM
by: HiddenLevers

By Yann Toulec

With everyone and their mother hating U.S. banks these days, I was surprised to see that it took U.S. financial stocks only a few seconds to recover from their daily plunge on Friday afternoon, right after the Fed announced that bank capital surcharges would be revised down to 2%. Then, I looked at historical data about U.S. banks, and realized that there is actually no reason to be surprised: financial stocks have been down for over three months now, some of them hitting prices close to their level of May 2009. And the fact that bank stocks are underpriced inflates the impact that small pieces of good news can have on their price, making me believe that a respite from the big slump is here, especially for options expiry.

So the question is – how do we know the banks are seriously underpriced? Well, fundamentals junkies would tell you some banks have P/E ratios of around 6.5, almost 2.5 times lower than the current S&P 500 P/E ratio. Sacrebleu, that is cheap! And that also explains why long-term value investors like Nicolas Sargen, Bruce Berkowitz, or Warren Buffet really like financials too. We macro guys can totally agree, but P/E ratios don't tell us anything about entry, or the turning points. On Friday, we had a lot of blood on the street, but the bank stocks were mildly green in a pool of red. That was an easy signal. Here's another one – look at last week's call/put activity.

Bank haters usually build their argument against financials around the regulatory uncertainty surrounding the industry and the high dependence to the housing market. It is true that more pressure will be put on U.S. banks as further points of the Dodd/Frank legislation are being discussed, and in this regard, Jamie Dimon's rant to Bernanke last week well summarizes the climate of mistrust between banks and regulators right now. But is it a surprise? No. It has been months now since markets realized financials would have to do business with tighter rules, and this risk seems priced in now.

As for correlation between the housing market and financial stocks, I don't need to assume. That's where HiddenLevers comes in handy. Using HiddenLevers screener, I found three stocks that have been statistically neutral to changes in the housing markets: Bank of New York Mellon (NYSE:BK), JP Morgan Chase (NYSE:JPM) and Bank of Nova Scotia (NYSE:BNS).

(Chart created using Hidden Levers app)

For our fundamentals-watchers, yes the decrease in most banks' loan-loss reserves does indicate that they have solidified their balance sheet and should be more prepared in case of a new housing shock. But I've got better things to do than to spend my valuable time pouring over balance sheets, bank by bank. Screening for quantitative correlation, and charting banks against housing levers is a much faster way to get there. That leaves more time for pétanque and long summer strolls along the Champs-Élysées!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.