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individualinvestor.com
by Steve Smith 12/13/99
Tech, tech, Internet.
That?s all that seems to go up these days.
But for the bull market to continue, it needs broader participation from other sectors. You know, breadth.
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So when the Philadelphia Bank Index (PHLX: BKX), which tracks 24 of the nation?s leading financial institutions, jumped some 16% in the five trading days following the October 28 release of the employment cost index data, money managers and traders cheered.
As most market veterans agree, a truly healthy bull market is one underpinned by a strong financial sector.
But as the BKX Index pulled back 14%over the ensuing two weeks ? even as the S&P 500 Index climbed into record territory on December 3 ? those recently jubilant money managers and traders have been quiet. As of last Thursday, the BKX was down 2.7% for the year to date.
However Friday?s 2.5% rise in the BKX on the heels of the surprisingly tame November Producer Price Index (PPI) numbers could finally be signaling the beginning of the rebound in bank stocks and perhaps other financial services issues.
Afterall, according to money managers and analysts, the two main issues weighing most heavily on the banking sector have been rising interest rates and Y2K. And right now the signs appear much more in banks? favor.
Indeed, last Wednesday, two days before the PPI numbers were released, the National Association of Business Economists estimated a 2.45% inflation rate for 2000. That compares with the 2.61% rate reported for the past six months.
The reason for the expected decline? Technology. It?s allowed for greater productivity, while pushing globalization forward and increasing competition.
General sentiment dictates that while the economy will continue to chug along, forcing the Fed to tap the brakes with one more 0.25-point hike, rates on the benchmark 30-year Treasury bond should stay below 6.5%.
PaineWebber economist Maury Harris notes in a recent report: ?We believe the Federal Reserve System in 2000 will operate with a tightening bias, but in fact [it] will need to tighten Federal Funds very little.? Harris says the yield on the long Treasury will likely remain below 6.25%.
Fears of Y2K-related problems have also plagued the banking sector in recent months. Though all the major U.S. financial institutions are well prepared and most industry analysts say it should be a non-event, many investors are still fearful.
?I?ve addressed many audiences. At the end my talk I ask the audience if they think Y2K will be a major problem. About 20% raise their hands,? says Dr. Edward Yardeni, chief economist and global strategist at Deutsche Banc. Alex Brown and one of the biggest Y2K alarmists. ?Then I ask who intends to take extra cash out of the bank by the end of the year, and about 80% raise their hands.?
Now imagine that question being posed to money managers. Many have been paring their positions in the bank stocks ?just in case.? And because the sector has underperformed the rest of the market over the past few months, these stocks are also prime tax-loss candidates for the rest of the year, adding further selling pressure.
I won?t make any major Y2K predictions, but I?m pretty confident we?ll all still be here, maybe a little hung over, but still here, on January 1, 2000. And apparently, investors will have some extra cash on hand to spend or put back into the market.
?The recent bank selloff is a consequence of investors having been conditioned over the past two decades to sell banks at the slightest sign of higher rates,? notes analyst Andrew Collins at ING Barings in a recent report. ?We are unlikely to experience the same drastic upward movement in interest rates [going forward]. This has created some good buying opportunities.?
Collins says bank earnings are well insulated from recent interest rate changes and expects banks to show earnings growth of 12.6% on average in 2000, outpacing the S&P 500?s expected 10.1% earnings growth. Currently, banks sell at a 50% discount to the S&P.
Nancy Bush, an industry analyst with Ryan, Beck & Co. cites the repeal of the Glass-Steagall Act, which allows banks, brokerages and insurers to more easily move into each other?s businesses, as a catalyst for mergers and acquisitions. She expects further consolidation after next year as Y2K concerns fade and before the ?pooling of interests? accounting method is phased out in early 2001.
So what bank stocks are analysts buzzing about?
Wells Fargo (NYSE: WFC - Quotes, News, Boards), which is expected to earn $2.58 per share in 2000 and currently trades at $44 per share, is among Collins? top picks. He likes the way banks have become more dynamic, full-service financial businesses.
He also likes Chase Manhattan (NYSE: CMB - Quotes, News, Boards), which he believes will benefit as it diversifies its revenue stream. Citing its recent acquisition of investment bank Hambrecht & Quist and its contemplation of creating a separate web business, Collins feels Chase is moving to broaden its traditional lending business.
Bush lists FleetBoston Financial (NYSE: FBF - Quotes, News, Boards) among her favorites for its stronghold on the lucrative Northeast region. Slated to earn $3.23 per share next year, Fleet is good value as shares trade at a 52-week low of $33, or just 10 times next year?s estimate.
While Bush currently rates Bank One (NYSE: ONE - Quotes, News, Boards) a ?hold,? she cites it as a prime takeover candidate. Last month Citigroup (NYSE: C - Quotes, News, Boards) was rumored as a possible buyer. Bank One shares have fallen to a 52-week low of $32 due to a slowdown in earnings related to its slumping credit card business. It?s expected to earn $3.60 per share next year.
Analyst Lori Applebaum at Goldman, Sachs just added Bank of America (NYSE: BAC - Quotes, News, Boards) to her ?recommended list.? It?s expected to earn $5.42 per share in 2000, a 15% increase over her 1999 estimate, and the stock trades near $50 per share.
Bottom Line:
Inflation remains benign. Y2K will pass. The sector is a screaming buy. You can take that to the bank.
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