Bank Stocks Big Winners As Liquidity Fuels Rally

Bank stocks have been red hot lately, easily outpacing other sectors of the market despite analysts' warnings that the industry's revenues are under pressure.

Especially in the past week, banks have been leading the stock market's climb to record heights in what one analyst called a "liquidity-driven bull market."

For the five trading days through Thursday, the American Banker index of the 225 largest publicly traded banks was up 3.35%, versus a 2.76% gain for the Standard & Poor's 500 stock index. Banks held their ground in trading Friday, despite some weekend profit taking.

Wall Street analysts, several of whom have downgraded the bank sector on fundamental concerns, advised caution.

"I firmly believe that if interest rates keep going down, then strength is going to be taken away from the banks," said Robert B. Albertson, director of U.S. bank research at Goldman, Sachs & Co.

"Right now investors are in the midst of the same knee-jerk reaction as always, buying banks when rates are falling," he said. "But we still have a neutral rating on the banks for the year."

"Until yesterday, the banks had actually underperformed for the year," said analyst Brent B. Erensel of UBS Securities. "In fact, they are playing catch-up in a liquidity-driven market."

UBS cut its sector rating on banks to "underweight" on Feb. 2. Mr. Erensel and other analysts at the firm anticipate "an absolute price correction of at least 20%."

Mr. Albertson, who was bullish on banks until early January, when his firm downgraded the sector to "market performer" status, said he has advised customers to use the current rally "to weed the garden a bit."

The analyst pointed out that loan growth at banks has been "decelerating rapidly." If the trend continues for another month, signs of an imminent recession will be clear, he said.

Mr. Erensel attributed the current rally to "buying by money managers looking for places to defensively position themselves." Another analyst agreed that nonfundamental factors are at work.

"You can't say there is this magnificent surge in earnings coming," said Richard X. Bove of Raymond James & Associates, St. Petersburg, Fla., "so something else is obviously going on."

He attributed the phenomenon to a shift by many employers away from traditional pension plans, which typically invested in the bond market, to 401(k) plans, which have provided more funds to the stock market as employees have opted for equity mutual funds.

"In the numbers each month from the Investment Company Institute, we see unbelievable amounts of money pouring into mutual funds," he said.

Looking to buy stocks, Mr. Bove said, fund portfolio managers have been attracted by the relatively low valuation of banks - many selling under 10- times expected earnings versus a multiple of more than 15 for the S&P 500. Yields are also attractive.

Meanwhile, the earnings outlook for banks, while lukewarm, is still better than for industrial companies as the prospect of recession grows, he said. In addition, takeover speculation helps the stocks.

"You have a situation where banks look comparatively good and money to be invested is pouring into the mutual funds looking for a home," he said.

In short, fundamentals have taken a back seat to the money flow into the market, he said. That seems unlikely to change until alternative investments become more attractive.

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