Now's the Time to Buy Bank Stocks

A reader asks the proverbial $64,000 question? If you like bank stocks, which ones do you buy? And the corollary question, do you buy an ETF?

There are good things and bad things about ETFs. Numerous popular books come down for and against ETFs. I like good old American stocks. I dislike having to buy both the "see" and the "saw" of an industry. Buy a health care fund and you are buying the hospital that is a labor intensive buyer of drugs and you are buying the drug company that spits out expensive pills at a mile a minute and sells them to hospitals. (After spending millions to develop them). The two stocks are very different animals.

I like regional banks. The smaller ones are going to be take over targets for years to come. One way to buy a boat load of them is in the Russell 2000 Value Fund (IWN), however, when you buy this fund, you also buy a boat load of basic materials stocks. You are buying the "see-saw". You are also paying an annual fee to hold those shares; the combination of up and down minus a fee will make your average return average less the fee.

The Regional Banks Index Fund (IAT) ETF is a pure play on regional banks. It holds mid sized banks such as BB&T Corp. (BBT), a bank that I like which is about 5% of the fund. Here again, you pay an annual fee to hold the shares. The fee is only .48% but over the long haul we are talking about serious money.

A good strategy is to look up the bank holdings in the IWN and buy a few bank stocks at random. Test after test show that random selection helps eliminate negative selection biases. Also select two or three from the holdings in the IAT fund. The idea is to buy a mix of small and middle sizes. You can find a list of the holdings at Yahoo Finance or at Google Finance.

Don't delay. On average, the market recovers something like half of the bear market losses in the first month or two of the turn. It is a huge mistake to wait for a clear market bottom. Part of the reason not to wait is that the market bottom will be made when the big capital goods, energy and basic material stocks hit bottom. This will not happen until bank stocks are well on their way to recovery.

Please note that the bottom in bank stocks (which apparently happened months ago) is accompanied by the bottom in real estate. If you ever plan to buy a second home, now is the time to get the best deal. Since fixed rate mortgages do not yet reflect the full decline in bond rates, one should start with a low spread variable rate loan.

Disclosure: None

Comments

[Pauly B:]

This article is pure lunacy. The market is almost broken. Now if I saw one centilia of improvement in jobs, housing appreciation, and purchases by businesses and individuals I might take the chance and buy some financials.

The biggest danger lurking is if this so called bailout bill doesnt work what will happen? The market is already pricing that into the equation now.

I think someone once told me never call a bottom, ummm, I think thats pretty good advice.

2008 Oct 05 08:20 AM

[Mr.G:]

venividi- I agree this is a dangerous move if done incorrectly -but if done in very very small amounts it might be rewarding - it would be ridiculous to go all in under the circumstances -but a very small investment at this juncture might also be wise especially since the US govt is now literally the market for the toxic credit derivatives and will certainly overpay bringing values up on these assets on banks books-even if they change the marked to market rule it is going to benefit
on the otherhand if the govt wasnt worried they would have lifted the ban on shortselling right after the bailout

2008 Oct 05 08:49 AM

[Toney:]

Bottom? We are nowhere near it, I fear.

2008 Oct 05 09:11 AM

[ZAIDANE:]

ONLY History will tell noboby knows.but i agree with the writer: time to invest is now.if you wait too long you will invest at the top of market .

2008 Oct 05 09:24 AM

[likeparty:]

Selected and well timed investment in regional and small banks can pay off handsomely in these very volatile times. Making heavy use of limit orders including stop loss can make for some very quick returns of 20% plus with minimal down side. Care and due diligence must be done but intelligent investors with cash to RISK can see superb and quick returns.

2008 Oct 05 09:37 AM

[CLH:]

Jack---I agree with you as I usually do. Each time the market tanks the banks barely move (see this week). The bottom for the banks was in July.

2008 Oct 05 09:55 AM

[t-bird:]

Earnings season is here. Wait for the financials to report b-4 committing your hard earned capital.

If he is correct and the Financial's spike, buy the SKF (inverse ETF on banks) under $100.

2008 Oct 05 10:38 AM

[Joe Red:]

Watch WB. He got in now with GS & GE.



I have a GE position.

2008 Oct 05 10:44 AM

[GaryCCB:]

We all do what we feel is right for our investments. Personally, I think it's too cloudy to go swimming. I'm playing it safe right now with lots of cash, a 25% position in TIP and a 5% position in GDX. Just waiting to buy some quality, under-valued gems. But not yet. Too much turmoil now.
Retired guy...

2008 Oct 05 11:06 AM

[doctordoom:]

Who knows for sure who's right or whether scaling in would salve those who wish to venture a position? You could also hedge.
Besides, the article did not state the time horizon. Seasonality, oversold and the FRB's largesse argue for a rally before year end.
One thing for sure. All comments should remain civil and respect the opinions of others. Personal attacks, especially profane, would tempt me to report abuse. Alas, who wants to stem someone's comments, especially when otherwise intelligent?

2008 Oct 05 11:16 AM

[searcher:]

I you are firm in your opinion and have confidence in your judgment and then you have no need to deflect negativity onto others. State your case and oppose error but no need to personalize the discussion. Deviation from this precept hints at an underlying lack of confidence in your own judgment.

2008 Oct 05 11:31 AM

[ZardozZ:]

The markets are trading more on emotions than fundamentals right now -- ripe for elliot wave theorists and technical analysis. Financial institutions are in unchartered waters and too many signs are pointing negative for equities. The selling into the rallies will be the mantra as the bear continues. If you have the fortitude to be a true contrarian in this environment go for it. If you don't you will be guaranteed to consistently make the wrong move. The volitiality will virtually assure that your fortitude will be tested as you delude yourself into thinking you can move opposite a stampeding herd and not be trampled in the process.

2008 Oct 05 11:52 AM

[leh:]

Agree the better (read cleaner) banks here look very strong, and Buffett claims the one and only stock he holds in his personal account besides Berkshire is WFC. I also like the volatility of beaten down regionals like SOV and NCC here as short-term trading vehicles (read 1-3 days or less). Not for the faint of heart, but I have to think some of these are at very attractive long term price levels as well--IF they're not hiding a bookful of nasty surprises.

2008 Oct 05 12:41 PM

[Fremont Rea...:]

It ain't over yet for the bank stocks. Expect more writedowns, and more to go under for their lunacy in lending critieria.

2008 Oct 05 01:13 PM

[Alan Young:]

I thought the bit about avoiding the "see and the saw" was well presented.
OTOH--
I love the part about selecting stocks at random to "eliminate negative selection bias." Wow! Is there any other kind? Let's all get random.

2008 Oct 05 01:25 PM

[Shiv Kapoor:]

disagree. An ETF is good for diversification of risk, but it does not address the solvency risk (only reduces it). The sector outlook on an enterprise value basis is positive. However, solvency risks remain elevated - i.e. even if enterprise value increases, the incremental valuation which might accrue to an existing shareholder will greatly depend on the method chosen in implementing the rescue package - for example, dilution by warrants granted to the government can significantly impact shareholder value of present shareholders. Me, I would invest only in entities who are positioned to benefit from the crisis and those whith strong balance sheets. The only one which comes to mind is Berkshire (& perhaps GS/GE but I would rather play those through BRK). Look to enter specific stocks only after specific solvency risks have been addressed.

2008 Oct 05 01:34 PM

[Philip Gvinter:]

I could not disagree more with the author. I have followed the banks closely and feel like the supposed "high quality" banks like USB, BBT, WFC, JPM, ZION, Hudson City and others who are trading near Jan 08 levels are ripe for a short while the heavily discounted but still solvent like SOV, FHN, perhaps NCC and others who are beaten up but who have taken the lumps they have coming to them (ALT-A wirtedowns >35% and done with their subprime) will do well on a relative basis. The problem is its very difficult to tell who is still solvent.

In the case of the "better banks" these valuations are CRAZY. They are trading at a huge premium to the rest of the peer group with no bottom in sight for either the housing market or the economy in general as unemployment continues to increase. Wells and BBT have lots of ALT-A, Prime Jumbo and construction loan exposure. These guys have painted a very optimistic picture by announcing default rates that are still below 1%. This cannot continue and they are being priced as if it can. I am not saying that these well run banks will collapse but simply that they have too high of a price premium relative to their peer group as well as an unrealistic future P/E which does not price in the issues they will inevitably face. In my opinion all of these stock still have anywhere between 25% and 75% downside risk as their earnings see the effect of a 2% to 3% default rate across their loan portfolios.

As for the "bad banks" some have taken aggressive writedowns on their held-for-investment portfolios which will exceed actual losses. Many have also faced the majority of their portfolio stress test on asset classes which are nearing the peak of their impairment or have even moved beyond that point. I believe that C at $15 or lower is a buy for this reason. I also feel that ALT-A loans should be separated into two distinct categories, Option ARMs which are toxic waste and regular ALT-A which will have high but not astronomic default rates and loss severity. The difficulty lies in identifying the banks who are furthers along in their portfolio stress test but who are still fundamentally solvent. SOV in my opinion belongs on this list. I need to gather more data on FHN and NCC but feel that they are strong candidates.

2008 Oct 05 02:21 PM

[Philip Gvinter:]

I also have to say that transparency is critical here. I am very leery of the overly optimistic and rather opaque numbers reported by JPM, WFC, BBT, and to a lesser degree USB. I feel that the lending standards industry wide were relative cookie cutters for each individual asset class (subprime, alt-a, option arms, prime jumbo, GSE saleable, etc.) and that the real qualitative difference was the level of exposure to the given asset classes and business models. Originate-to-securitiz... is pretty much dead. Option ARMs are the most toxic waste still outstanding but the big players (CFC, WB, WM, DSL, FED, BKUNA, AHM) are either dead (AHM, WM) on life support (DSL, BKUNA, WB) or a great short (FED.) The one thing that I think we can really learn from is the approach that institutions have taken to deal with the issues. Those who have maintained relatively high transparency are absolute steals at these prices as long as they are solven. Those who moved held-for-sale assets into held-for-investment in order to avoid taking writedowns and who seem to have default rates which seem lower than those which should come from their lending program mix look very suspicious and like the next CFC or WB.

2008 Oct 05 02:28 PM

[Mr Ed:]

Good way to play the banks, the risk is spread out over many names. If you were to play regional names i would stay away and wait for a pull back from 52 week highs and look for quality names with good take over potential because of a large deposit base and great location(foot print). Example STI, a very large Regional with a good foot print and is way below its 52 week high with demographics coming into play, you will be in the right stock. It is still a news driven market, so scale in to any buys.

2008 Oct 05 03:42 PM

[Pessimistic...:]

Lot of chatter on the right move.. stay out, get in, buy down.. hold, sell . It is a crap shoot. I am sticking with the strategy that there are some great stocks that are now buys because they are too low not to buy and if they continue to drop... dollar cost them down in encrements.. your choice on amount.
Get the dividend and sit tight. They are not going to zero.. my stance is prove it to me.. I didn't buy high and these under 10's are now speculators.. even under 5 for some.
WB was a superb ex. of a cheap stock that popped on WFC news. And buddy pal Warren own's only one financial, WFC? Come on.. I'm long JPM and BAC.. I will dance with WB again.

2008 Oct 05 07:29 PM

[Investa Mania:]

This post is pure lunacy as many people have expressed in the comments.

Jack, has the list of 110 or so regional banks that are in trouble right now not reached you ??? Do you know how much "toxic waste" they are all holding right now?

This is not just your casual bear market Jack, the market is changing itself. The financials and the banks are not just going to jump up again. Easy credit will no longer be available in the next few years as it was before, lending will be reduced....this all means less fees etc = less profits for all these banks. Moral of the story is that even if there was to be a rebound, the growth would be small in the sector.

If you're looking to buy, stay away from the financials...if anything, stay away from the equities market because the rocky road has just started.

Buying anything on banks right now is insanity. After 2 weeks of all major investment banks going down the drain, and banks globally being saved by diff govs....you're saying, alright, lets buy?

Follow the money...and invest there....that is....buy T-BILLS and don't lose your money

2008 Oct 05 07:38 PM

[ozcutty2:]

Bank stocks aren't cheap, most are up 50% + from their lows

2008 Oct 05 07:43 PM

[Urbane Gori...:]

Pessimistic Optimist... I think you meant 'increments', not 'encrements'... But then again, you might have meant 'double down in excrement'... Hard to tell...

jegan ;-)

2008 Oct 05 08:28 PM

[Takayama:]

Want know the answer? Refer to the history of the Japanese Nikkei meltdown. But put in a multiplier of more than 1.7 to factor in the derivative market contributions, war on terror, Iranian nuclear conflict, wars in Afghanistan and Iraq etc.

I believe it may be better to put my money in Intel, AMD, MacDonalds and Lenovo.

2008 Oct 06 06:25 AM

[BLSH:]

Take a look at FHN

2008 Oct 06 10:37 AM