Why the Market Is Focused So Heavily on Bank Stocks

Tuesday, Feb 3, 2009  |  Updated 3:03 PM CDT
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Wall Street has chosen the highly volatile banking industry as its ticket to ride out the recession.

As the government prepares key measures to help rescue the ailing financial sector, bank stocks and the broader indexes have moved in unison, rising together even when the news seems bad and falling together when the news gets even worse.

Both moved higher Wednesday as the government neared creation of a "bad bank" to swallow the toxic assets on the books of financial institutions and as Congress moved forward on President Obama's $825 billion stimulus plan.

The gains came even as banking giant Wells Fargo (NYSE: WFC) posted a quarterly loss and with little other news that seemed to justify a resurgence in the battered sector.

"Anything is a cause to get excited about banks," says Diane de Vries Ashley, managing partner at Zenith Capital Partners in Coral Gables, Fla. "People are desperate for that kind of excitement and I almost don't think it's going to matter what the news is, as long as it's some news and has a level of positivity that banks can go do what banks do."

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Though market pros still caution investors against buying the financials, the overall market seems willing to ignore much of the negativity about banking and focus on the positive.

The move Wednesday capitalized on momentum earlier in the week when the Dutch government announced a measure similar to the bad-bank strategy that would lift about $13.4 billion in toxic assets from financial services titan ING (NYSE: ING).

The company suffered under the burden of bad alt-A mortgages the likes of which have dogged the big US banking names. The Dutch government's move was seen by many in the market as a precursor to the tact President Obama's administration would take towards the domestic banking crisis.

"They're finally coming to grips with the fact that until you remove these assets nothing is going to move," says Quincy Krosby, chief investment strategist at The Hartford. Otherwise, "The banking sector will sit and sit and not go anywhere."

Video: Markets, Bad Banks and the Fed

Wall Street had been waiting for the Obama administration to show its hand on dealing with the financial crisis, and the tide of optimism about the bad-bank scenario reflected the market's hope that the administration's moves would be quick and deliberate.

"In a capitalist economy, the banks are basically the engine and you can't drive a car without the engine being in good shape," says Michael Cohn, chief market strategist at Atlantis Asset Management in New York. "When they're losing capital right and left they really have no incentive to take any risk on the lending sector at all.""

The enthusiasm translated into a sharp spike in the financial sector.

In addition to the surge from Wells Fargo, State Street (NYSE: STT) soared more than 30 percent just days after the bank said it was getting pounded by mark-to-market accounting rules and warned of a difficult year in 2009.

Institutions including Bank of America (NYSE: BAC) and Citigroup (NYSE: C) that had been slammed by the crisis in confidence over the sector also sharply rebounded, and the Financial Select Sector SPDR (NASDAQ: XLF) exchange-traded fund, which follows the industry's movements and holds its biggest names, posted a large gain.

Yet questions remained over whether the rally was sustainable.

While the notion of having the government purchase the bank's toxic assets is on its face positive for the industry, the price tag for the Troubled Asset Relief Program, Krosby says, will swell past $1 trillion.

In addition, there will be considerable deliberation over the details, particularly what price the government will pay for the bad assets and what ultimate effect the buyout will have on the sector, which is still bound to see a considerable amount of institutions fail. Finally, there's concern that while bank balance sheets will get better and the industry will be encouraged to lend, the underlying securitization businesses, where loans are bought and sold, also will need to strengthen.

"The initial approach toward a bad-bank concept was there wasn't enough money, and events spun out of control," Krosby says. "You have to ask what's the price tag sitting on those banks. Also along with this, there's a question as to basically which banks are they going to work with."

For investors, it will be tough sledding figuring out whether a bank rally can last at this point.

Analysts including Cohn suggest that even with Wednesday's spike the market essentially remains in the same trading range where it has been since bouncing off the November lows. And he wonders whether the enthusiasm isn't equally tied to the stimulus plan, which could be another short-term burst for the market.

"During the bad news everything was gloom and sell-'em off drastically," Cohn says. "Once all the news is out everyone can breathe a sigh of relief until the next round."

At least for the short term, though, the market is likely to grasp at any kind of good news it can find to move higher.

"There's a semblance that there's not a solution but a working and workable means by which to plow your way out of this," Ashley says. "There's no magic solution. It's a slog. If you have a market that is reacting well to the kind of slog they see, hallelujah."

For more stories from CNBC, go to cnbc.com.

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