Bank shares are out in front of the historic rally in the stock market.
The American Banker index of bank stocks has surged 17% so far this year, while the Standard & Poor's 500 stock index is up 8.5%. The Dow Jones industrial average has improved 8% while crossing the 7,000 mark.
Bank shares continued to climb Friday, even as the broader market took a breather.
"The banks are probably at peak levels of profitability, and asset quality is as good as it's ever been," said bank analyst Kenneth F. Puglisi of Sandler O'Neill & Partners, New York. "Plus, they have more capital than they can use, and they are buying back stock."
Though some observers warn of a possible downturn for bank shares, many see the good times continuing.
"The worries of a year ago-that inevitably higher provisioning levels would (depress) bank earnings growth-appear to have been unfounded," said Marni Pont, an analyst at Keefe, Bruyette & Woods Inc., New York.
The bank rally, which has accelerated in the past two weeks, comes as the general market is hitting unprecedented highs.
The market is being lifted by "benign news on inflation and interest rates and by another load of cash that was dumped into the eager hands of mutual fund managers," Mr. Puglisi said.
Indeed, the mutual fund industry last week estimated that $24 billion had poured into stock funds during January, the fourth-largest monthly inflow on record.
January is typically the strongest month of the year for such inflows, as new 401(k) retirement plans are established and employers match employee contributions to existing plans. But strong inflows have continued into February.
"This is a liquidity-driven market," Mr. Puglisi said. But he emphasized that banks are also benefiting from their fundamental appeal right now.
Despite their impressive gains, bank stocks generally continue to trade at a discount to other stocks on a price-to-earnings basis, Mr. Puglisi said.
"The banks certainly don't look out of line on a price-to-earnings basis. The only real question is whether the earnings estimates are good," said Mr. Puglisi, whose firm specializes in smaller-capitalization bank and thrift stocks.
The relative cheapness of bank stocks looks highly attractive to fund managers with a river of cash to invest. "Portfolio managers are not paid to hold cash," Mr. Puglisi noted.
With many issues now at record levels, some believe a painful correction is inevitable.
"My biggest worry is that things are so good, and that it won't take much for it to become less favorable," said analyst David Corkins of Janus Funds. "If interest rates are bumped up a lot, it won't derail bank stocks, but they certainly could come under pressure."
Lawrence W. Cohn of PaineWebber Inc. noted: "This is a traditional cyclical industry. Because the economy has been so good for so long, those who are increasingly investing can't remember the last cycle.
"The bad news is that there will be an end to the cycle," he added.
Right now, bank earnings trends indeed look very good, according to a composite study of the nation's 50 largest banking companies by Keefe Bruyette.
"The top-50 composite earned $35.9 billion in 1996, equivalent to a 16% return on equity and a 1.1% return on assets," Ms. Pont said. That is record performance.
Keefe's 1997 outlook for banks predicts that revenue growth for the top- 50 composite will slow to 6%, from 9% last year. But with expenses expected to rise just 2%, and a 15% rise in credit expense, pretax operating earnings could rise 12%, Ms. Pont said.
Bolstered by further share repurchase moves, the analysts said, growth in earnings per share at the top 50 is expected to grow again by more than 13% in 1997.
