In part one of this series, we came up with several technology stocks that I have deemed worthy of selling in anticipation of a market pullback. We have established that their gains were due (in part) to the market's "rising tides." In this piece, we are going to look at some financial stocks for similar reasons. As with the previous article, we started with some basic understanding.
You'll always know that you are in a bull market whenever each trading day follows one where records and weekly, monthly and yearly highs are always mentioned. Where earlier this week both the Down (DIA) and S&P500 (SPY) reached key decade-old milestones and another on Friday as the Dow surged higher, closing near its four-year high. However, this time it was the Nasdaq's (QQQ) turn after its index hit an 11-year high. This time the optimism was spurred by job growth. The U.S. economy created jobs at the fastest pace in nine months in January and the unemployment rate dropped to nearly a three-year low of 8.3 percent, the government said.
Still not convinced we are in a bull market?
Consider this, across all of the sectors trading on the market, 450 separate stocks have recently reached 52-week highs. This is the highest reported total since last July. In 2012 so far, it seems to be an everyday occurrence. Aside from a company such as Apple (AAPL), which continues to rise and will likely do so through the quarter, while looking across all of the indices, the signs of being overbought were apparent on a great majority of the stocks that are showing such momentum. A recent analyst suggested that 74 percent of stocks were over their 200-day trading averages. The question now becomes, is it time to be fearful in the market if you follow the preaching of Warren Buffett?
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Clearly the year-to-date sector performance above shows that investors are not only excited about what lies ahead in 2012, but have become decisive about what industries matter the most. So again, with such early gains and with the broader indices having approached record territories, should investors be in a fearful mode and begin to lock in some profits as the bear market may be just around the corner? This question is not that difficult to answer if one has studied recent history.
Trading the sector gains
They say "a rising tide lifts all boats." There is unquestionable truth in this theory especially in the stock market as evident by this bullish run we are now seeing. So when it comes to stocks, we need to understand that a strong economy can propel even the most challenged business models.
In this, the second of a series looking within each sector, we are going to try to identify certain financial stocks that might be on the verge of a pullback and ways to possibly mitigate some risk and exposure to losses. The benefit of this is that if you are on the sidelines, hopefully you will be able to get an idea of a possible good entry point.
Trading the financials
JPMorgan Chase (JPM)
The bank has always been considered "the moral standard" amongst the banks - primarily because of how it managed its credit exposure during the housing bubble. In other words, it hasn't been categorized as a predatory lender to the extent of its peers. Recently, the company reported its fourth-quarter earnings and without putting too much spin on it, the results were pretty weak. Its earnings were down 23 percent compared with the same period a year earlier. It said that it was hurt by a fourth-quarter slump in investment banking as well as other Wall Street businesses, which suffered amid the sluggish economic recovery.
On the bright side, the bank showed tremendous growth in corporate loans. The commercial banking unit's profits rose to $643 million, a 21 percent increase from the previous year, as lending to corporations grew for the sixth consecutive quarter. For JPMorgan, the stock is up over 15 percent on the year in large part due to the overall sudden resurgence in financials. With the stock currently trading at $38.28, I sense that on any market pullback, it is reasonable to expect a retrace to its 50-day average of $34 or possibly lower although it will show some support at that $30 - $32 level.
Bank of America (BAC)
Investors have to appreciate where Bank of America is today and match that with realistic long-term horizons. I think it is still too early to say with any degree of certainty that the bank is back on track. But the stock is getting very interesting. I've discussed Bank of America quite a bit because the stock has the potential to double from current levels. But it is going to require a great deal of patience to make money.
Before I delve deeper into Bank of America, I want to first point out that I think the stock is going to $10. I have not changed my stance on this and I think its fundamentals are improving enough to justify this (long-term) valuation at some point during the year. Having said that, the premise here being "trading" I think there are some opportunities to both lock in gains and buy at lower levels in anticipation of its upward movement toward $10. The stock is currently trading just under $8 while its 50-day average is right at $6.
Citigroup's stock is up 27 percent on the year so far and more than any of its peers, I think this is one where profits should be immediately locked in. The stock currently trades at $33 while its 50-day moving average is 20 percent lower at $26. As high flying as the stock is currently, the reason for concern has to do with the fact that (unlike its peers) it recently missed its earnings expectations.
Citi reported fourth-quarter earnings that did little to inspire confidence that the bank can indeed get back on the right track. The company reported profits that fell 11 percent and missed Wall Street estimates. It seems that the concerns regarding European debt have had a significant impact not only on its capital markets, but it has hurt the bank's trading revenue as well as discouraged clients out of some possible large deals. For Citigroup it's a case of the old cliche "one step forward and two steps back." As with several other banks within the sector Citi continues to struggle to prove to investors that it has any value. Today, it seems that the optimism, as quickly as it arrived, has all but faded away. The question is, is there more room on the downside?
Goldman Sachs (GS)
Goldman Sachs is up 30 percent on the year to $117 and is likely due for a pullback to the $100 area. Fellow Seeking Alpha contributor Stock Croc offered what I thought was an excellent bearish case for the stock. In a recent article, he said the following:
Goldman Sachs, despite reducing its long-term debt in the third quarter 2011, does not have a particularly strong balance sheet with a high debt-to-equity ratio of 3.3. This does not bode well for price stability or the company's future earnings if we were to see a double-dip recession eventuate or further economic headwinds from a prolonged European debt crisis or Chinese property bubble collapse.
Those are indeed extremely valid points. But I sense that these metrics are virtually interchangeable within the entire sector. To me, the stock has the potential to reach $150 - $200 price target over the next two to three years. But in the near term, it is due for a pullback to the $100.
Wells Fargo (WFC)
Wells Fargo's stock is up 11 percent so far on the year. While it's not an outrageous climb, it will likely go lower on any market or sector pullback toward its 50-day average of $27. As with other banks within the sector it still has a lot of work to do to clean up its balance sheet. And one has to consider that its acquisition of Wachovia will take some time to fully integrate.
Though its recent earnings announcement was somewhat of a disappointment, the bank should have no problems producing decent returns on equity - I would project 10 percent to 15 percent. As with Citigroup, this potential makes it a compelling long-term buy at current prices - even at current levels. But the short term suggests that a pullback below $30 just might be imminent.Disclosure:
I am long BAC.