Buying banks can be 'dangerous investing'
Bread-and-butter banking business has been slow, and analyst Dick Bove worries that the regulatory environment could make matters worse.
Analyst Dick Bove is one of the market's biggest advocates for bank stocks, but he is worried that investors may be getting a little too enthusiastic.
While financial sector companies on the S&P 500 have shown 24% earnings growth for the second quarter, Bove noted that not all profits are created equally.
In this particular round, banks have racked up strong profits on non-core areas such as accounting changes and one-off items such as sales of assets.
As for core assets, though, the results been less than impressive. Bread-and-butter banking business has been slow, and Bove has worried that the regulatory environment could make matters worse for the 28 large banks he rates.
Consequently, investors need to choose carefully.
"The second quarter results of these companies indicate that for the vast majority there was no improvement in core earnings but a significant improvement in reported earnings," Bove said in a note to clients. "In the past four years, if these banks reported earnings in this fashion, the 'shorts' would have and were all over their stocks, arguing that the companies were still deeply troubled and that these companies had no future."
Instead, investors have continued to scoop up bank stocks, pushing the KBW Bank Index ($BKX) up nearly 12% since the late-June trough.
That has occurred even as lending has dried up -- JPMorgan Chase (JPM) and Citigroup (C) reported actual declines for the past quarter despite stellar profits -- and the trading business becomes an ever-tougher proposition.
Psychology, Bove said, has trumped analysis.
"The psychology of the past four years was that banks could do no right and the stocks should be sold," he said. "The psychology today is that banks can do no wrong and the stocks are being aggressively purchased. What stimulated the difference in attitude is a long-term view of economic and financial developments."
The previous psychology was that banks would have a hard time generating earnings.
The new psychology is that "banks have meaningful earnings power," Bove said.
"Which view is correct? I think, as I have for the past four years, that these stocks are still cheap and that they should be bought," he said.
But, he added, "when assessing the companies...look for those that have shown core earnings growth. However, at this moment, it appears that any bank stock will do as long as it has the name bank in it. That is dangerous investing."
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