Nasser Khraishi's  Instablog

Nasser Khraishi
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I hold a PhD in Electrical Engineering (Control Theory) from Stanford University and a Masters Degree in Engineering-Economic Systems (now called Management Science and Engineering at Stanford). I have been fascinated by the stock market since I was 14 (that is 37 years ago at writing). It has... More
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Quantitative Finance
  • It May Be Time To Sell Bank Stocks 0 comments
    Oct 28, 2013 5:07 PM | about stocks: BAC, JPM

    I, among many, was of the opinion that the JPMorgan (NYSE:JPM) settlement with the Department of Justice was an excellent way out of the labyrinth of regulatory action. A move that I thought other banks should follow.

    The logic, which I stated in a previous posting, was that JPM has settled all regulatory action in exchange for potential criminal liability. In essence, objecting to a regulatory action puts the burden of proof on the bank. With criminal action, the much heavier burden of "proof beyond reasonable doubt" is on the prosecutor. Hence, one would reasonably conclude that this was a good tradeoff for the bank.

    It seems most of us were wrong: the DoJ has outsmarted all. You see, this piece of news about Bank of America (NYSE:BAC) changes everything. By turning to FIRREA, the Department of Justice can escape the "beyond reasonable doubt" clause. Hence, proving fraud to a jury can become a whole lot easier, as was successfully demonstrated in the Bank of America case mentioned above.

    This DoJ strategy puts banks at the footsteps of an open pit, with immeasurable potential litigation risk. The idea that settling with the DoJ can spare banks walking in the footsteps of the Tobacco industry may have evaporated in the short run. Valuations of banks from this point on should take into account what skeletons were buried in closets, if any, during the financial crisis. For us as open-market investors, we can never know, unless either a bank comes out clean or the Department of Justice sues.

    I did subscribe to the "Don't put your money in the bank, buy the bank!" mantra. Up till the early 2000's, investment returns from buying bank stocks, combined with dividends, have always outperformed fixed income investments. Yet, the following eye-opening charts bluntly state that the bankers themselves may have been the only ones who benefited from bank returns in the past decade. Save GS (with a dividend yield of 1.36%) which beat the S&P500 over the last decade, JPM (with a yield of 2.88%) , and WFC (with a yield of 2.8%) are the only ones of the major six I follow that came close to matching the S&P500. The other major banks (MS, C, BAC) do not have meaningful dividend yields anymore, and have severely underperformed the S&P 500 over the last ten years.

    As such, it is my opinion that the risk-return has suddenly shifted against holding bank stocks, with any hopes of meaningful returns delayed till the litigation overcast begins to clear.

    Disclosure: I am long JPM. 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.

    Additional disclosure: DISCLOSURE: JPM, GS and MO are in my trading-set.IMPORTANT DISCLAIMER: It is important that you understand and agree that all information provided in this newsletter rely on publicly available data and tools with no guarantees of quality or suitability for any purpose, and that I can be long or short in any of my trading-set equities, at any time, with or without regard to indicated trends and described analytics, and that I do not give buy or sell advice or any other financial recommendations, and that any and all actions based on this commentary are solely the responsibility of the reader.

    Stocks: BAC, JPM
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