Want a rally? Start rooting for banks

We can't have a lasting recovery without the financial sector.

By InvestorPlace Nov 10, 2011 10:26AM
By Jeff Reeves, InvestorPlace.com


Bank stocks and the financial sector have seen their share of ups and downs in the past three years -- though decidedly more downs than ups.


On the retail banking side, Bank of America (BAC) is off almost 86% since its 2008 peak, and Citigroup (C) is down nearly 90% in the same period. On the investment banking side, Morgan Stanley (MS) is off more than 67%, and Goldman Sachs (GS) is off 52%. A host of other financial stocks, large and small, have felt similar pain.


It might seem like a natural reaction to wag your finger at the big banks, since the institutions got exactly what they deserved for their reckless role in the subprime mortgage meltdown. Actually, shaking your fist in anger may be more apt, as one can argue that "too big to fail" institutions got a pretty plush deal with a no-strings-attached bailout and executive compensation that boggles the mind.


But here's the harsh reality of our current economic quagmire and the fragile rally on Wall Street: We simply can't have a lasting recovery without the banks.


That's why each and every investor out there should cheerlead for the financial sector -- every day, for as long as it takes.


Otherwise, we are in for a very long and difficult road ahead of us.

 

Post continues below:

Financials hold back the market

We'll get to some big-picture stuff in a second, but let's start with the biggest reason investors should root for banks: cold, hard cash.


Simply put, when banks rally, the market rallies. And when banks crash, the markets crash. So unless you are going to go perpetually short, you want to see banks stabilize and start growing -- fast.


A look at this chart shows the biggest one-day moves for the market this year on Aug. 8 and 9. The correlation between big moves for the market and big moves for the banks is clear -- and bears itself out in less dramatic fashion across other volatile days in the market this year.


Admittedly, the big move on Aug. 8 had a lot to do with macro issues -- the credit downgrade of the U.S. sparked the selloff. But as the headline of my column at the time read, the U.S. credit downgrade changed nothing. In fact, rates briefly dipped as low as 1.9% for the 10-year T-Note. It's also worth noting these stocks have a lot of pull on the broader indices because BofA and JPMorgan Chase (JPM) still are in the Dow, and the market-cap weighting of the S&P 500 Index means megabanks hold a lot of sway.


But all that aside, we should all agree that -- generally speaking -- sentiment was a bigger factor in August after the downgrade. And sentiment is what's driving bank stocks, pure and simple, since accounting tricks at financial stocks make numbers difficult to trust.


Thanks to the power of fear or greed on this sector, as investors get bullish, they get into banks big-time. As they get bearish, they run screaming from financials.


In short, a rally in banks means a gush of market optimism -- something that all investors should be in favor of.


'Credit' is not a dirty word

The performance of banks, of course, goes beyond the performance of their stock. Investors need bottom lines to shore up and "core" lending to consumers to increase and remain robust. That will help not just stock prices, but the economy.


I know what you're thinking: Liar loans caused the financial crisis. But the simple fact is the vast majority of responsible Americans could not buy big-ticket items at all without credit.


Yes, Americans probably should save more. Before the recession, in 2005, the per-capita savings rate of the U.S. was on par with South Korea at a little over $5 million per every 1,000 residents. That's a paltry $5,000 per person.


But consider that even in this depressed real estate market, the median home price in the Northeast is more than $240,000 -- and exceeding $150,000 in the more affordable South. Even if you double or triple the per capita savings, it's still going to take a big loan to buy a house.


Don't believe in the "American dream" of homeownership? Credit isn't limited to mortgages. Most start-ups could not get off the ground without a small-business loan. And even credit cards have their utility, with millions of Americans of modest means relying on credit to pay for unexpected car repairs or a replacement refrigerator.


Obviously, irresponsible lending and irresponsible borrowing got us to our current economic quagmire. Greed got us into this mess, and will not get us out. But responsible use of credit is a crucial way to build personal wealth as well as broader economic prosperity.


Banks must be partners in growth

Of course, responsible credit is easy to explain but obviously more difficult to put into practice. Take MF Global, which pulled an AIG by leveraging up 30-to-1 on risky euro zone debt. Weren't these turkeys paying attention three years ago?


This is what makes it so hard to root for banks. Everyone hates Bank of America (yes, everyone -- and here are five reasons why) and its hubris. Everyone hates the golden parachutes across the industry, like the $30 million farewell Bank of New York Mellon (BK) bequeathed on CEO Bob Kelly after "disagreements" with his board earlier this year.


And most of all, everyone hates TARP. Many feel that the Troubled Asset Relief Program didn't do anything to increase lending and only helped the biggest banks get even bigger thanks to government financing for buyouts.


Occupy Wall Street sprung up, in part, out of this anger. It's a feeling that banks are not partners in our economic prosperity but -- to borrow from a famous Matt Taibbi article in Rolling Stone -- vampire squids, sucking us dry for the sake of their own profits.


We need banks to be on our side as investors, consumers and workers. Otherwise, we are doomed to suffer the inflation of another bubble at best and a sequel to the Great Depression at worst.




Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.



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10Comments
Nov 10, 2011 3:34PM
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It is quite sad to see how little value some people think the Bank's bring to the economy, and how vital they are.   The truth is as outlined in this article, that they are vital.  Hoping these Bank's fail is like hoping for your own financial failure.  Because if one them fails, you will see a complete lock up of the financial markets and banking system that could last a long time.  Be very careful what you wish for. 

I suspect most of the negative comments being posted on the Banks are not from investors or are short sellers.  

Any investor already knows there can be no sustainable turn around in the markets, pension funds, 401k's or whatever, until the Banking sector can put this dark period behind. 

Red billy's comment is so true.  During the boom time everyone was happy.   Its turned into the classic buy high sell low.     Come on America, enough with the finger pointing.  Lets get back to rebuilding the greatest Country in the world!

Nov 10, 2011 11:17AM
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What a load of crap.  Banks produce absolutely nothing.  All they do is provide a means of exchange for goods and services of different value (i.e., they hold our money for us).  In return for this service, they are supposed to earn some amount (i.e., interest on loans, fees on accounts). 

 

The financial mess of their own making was that while holding our money for us they decided to open a casino where they place bets with each other (over the direction of the stock market, commodity prices, real estate, etc.).  None of which add any value to the economy as a whole.

 

Frankly, if you want the economy to take off, we have to release the capital that is tied up in these financial institutions.  The carrot and stick approach would be as follows:

 

Carrot - Extend rapid depreciation for capital purchases (e.g., depreciate over 2 years rather than 5-7), and a tax credit that knocks 2% off of the payroll tax for every employee added to the corporate payroll.  This will encourage businesses to hire people and buy new equipment.

 

Stick - a 10% surtax on capital gains from non-business over $150,000 each year.  This will make it more expensive for businesses to sit on large cash reserves counting on the investment income to pad their bottom line.

 

 

Nov 10, 2011 1:43PM
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It all came home to roost in a bad way. Funny thing is when the madness was taking place in 2003-2007 stocks were up, real-estate was up, the economy was booming, and most everyone was happy. Most. Like probably 95%. I was in the 5%. When the topic came up at cocktail parties and family get togethers I could not find one person to agree with me that we had a bubble going on and that these sub-prime loans were a bad idea, and it was all going to blow up. Not 1. So all you people that thought it was wonderful you are part of the problem too. You got exactly what you wanted and getting what you deserve too. Where was OWS 5 years ago? Taking out $50,000 home equity loans on a home worth half of what it was appraised at and partying about it. Karma Rocks!
Nov 10, 2011 1:26PM
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There is a lot of discontent and outright anger at big banks.However,just like Democracy (a flawed method of rule) banks are the best method we have available. They have been around for hunreds of years and offers the best method to acquire wealth for those needing business loans.

Constraints have been placed on their activity in stocks, etf's,and other exotic investments,but were recended by our "flawed government officials" prior to the big economic crisis.Banks simply took advantage of the situation to make fast money .We now know it was a reckless avenue to pursue.

Re-instatement of these rules is all that is required and all the lobbying in the world shouldn't be allowed to endanger our lending institutions. NUFF SAID.  

Nov 10, 2011 1:40PM
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Move your money to a credit union and to heck with the big guys like BAnk of America etc.. Maybe they'd finally get the point and straighten up their act if they lost at least 50% of their customers.
Nov 10, 2011 10:57AM
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MSN Money, CNBC,  Wall Street butt kissers, screw the banks.
Nov 12, 2011 7:53PM
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Yeah, let those evil banks all go bankrupt.  They produce nothing and add no value.  Let's go back to paying for everything with cash, which we can keep buried in coffee cans in the back yard.  Who needs ATMs, debit and credit cards, and checking accounts?  We can drive down to the utility company office every month to pay our electricity bill in person.  And we don't need auto loans or mortgage loans.  We can just save up our money until we can pay all cash for a car or a house.  Or better yet, maybe we should go back to the barter system.
Nov 11, 2011 11:17PM
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Have all the incompetent and thieving banks go bankrupt. New competent and trustworthy ones will emerge and replace them. THEY ALWAYS DO! Simple business and economics 101! For every failure, there's a success to take it's place.

 

Throw all rich criminals in jail or out of the country and shut down and ban Fraud Street forever. WE WILL BE MUCH BETTER OFF AND MORE SUCCESSFUL AS A COUNTRY IN THE LONG RUN!

 

Money is no object when it comes to creating a rich and successful country! READ MY LIPS..... There is no such thing as DEFLATION when speaking of monetary policy. You can keep printing all the money to your heart's content and always keep it at the SAME value. You can even print a NEW currency to replace the old currency, rendering that old currency worthless. Again, DEFLATION doesn't matter, DEFICITS AND BORROWING FROM OTHER COUNTRIES DOES MATTER! Simple economics 101!

 

This country is doomed unless I or someone like me becomes President to save this backward and upside down society of ignorant fools.

Nov 10, 2011 6:16PM
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It is quite sad to see how little value some people think the Bank's bring to the economy, and how vital they are. The truth is as outlined in this article, that they are vital.

 

They are vital participants, but their success should FOLLOW the improvement in the economy, not be the source of it.  What do banks PRODUCE?  They borrow money (either from depositors, the government or each other), and they lend it to other individuals (who use it for their purposes).  At least that was the way it was supposed to work, but instead the borrowed the money and place bets on another bank's debts and then they bet on whether the insurance company is going to go under trying to pay off the bet.  When the bets started going against them, they stopped in their primary function first (lending money), which has the country locked into this mess.  The answer is to get the commercial banks out of the investing game altogether by reinstating Glass-Stigall (even if this means forcing the big banks to drop the illusion of commercial banking and let new regional and local banks handle that.

 

 

Nov 10, 2011 2:43PM
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A bank is a financial institution that serves as a financial intermediary.
Smile There are central, commercial and investment banks. I'll root for all those except those that participated in the deception and fraud that got us in this current situation.  That means I will not root for AIG, Bank of America, Goldman Sachs, members of National Association of Realtors that duped buyers or borrowers that participated in loan fraud.  
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