Bank stocks, woefully out of market favor right now, could entice investors again by next spring, unless the economy seems headed toward recession by then.
"There are some leading signs of a slowdown. Around six ms from now the question is going to be: how serious is this?" according to Robert A. von Pentz, chief investment officer of Riggs Investment Management Corp., Washington.
An imminent recession might trigger a general 20% decline in stock prices. A less ominous scenario could bolster shares of banks, perceived to fare better when rates are stable or falling.
"My sense is that the Federal Reserve is not fighting excesses in the economy, unlike during some past periods, and is not trying to start a recession," said Mr. von Pentz.
His firm, a subsidiary of Riggs National Corp., manages about $2.5 billion of funds and is an investor in major banks. Riggs Management's largest bank stock holding currently is in New York's Citicorp.
The money manager thinks the central bank's shift to tighter monetary policy early this year is only now beginning to affect the economy.
"There is always a lag of from six to nine months before there is an impact on real economic activity," he pointed out.
Now incipient signs of cooling are appearing in both the automotive and housing sectors. "The auto companies' [third-quarter] profits were better than ever, but the growth trend is beginning to flatten out," he said.
"Autos and housing are big drivers of the domestic economy, which means there is a slowdown out there somewhere and that pressure comes off interest rates at some point," he said.
"When that happens, it can ignite a bond rally and some of the ignore credit-oriented companies can do a little bit better," he said.
But for the time being, Mr. von Pentz expects short-term interest rates to continue rising, and his holdings of banking stocks are limited.
The next rate hike could well come a week from tomorrow. The Fed's policymaking Open Market Committee is due to meet on Nov. 15.
But while the Washington money manager and others in the extended Wall Street financial community appear unanimous about the certainty of further rate hikes, they are not so certain about the strength and staying power of the nation's economy.
Some think the Fed's series of rate increases since February have set the stage for a noninflationary "soft landing" of the economy. Others are doubtful the expansion can be cooled down that easily.
"Even given the Fed's 175 basis-point dosage of tightening medicine, the expansion still is well entrenched," said Robert G. Dederick, chief economist at Chicago' s Northern Trust Corp., in reviewing recent economic data.
"Housing has started to erode at the foundations, but personal consumption (up 3.0%), business capital spending (up 7.0%), and exports (up 9.8%) go their merry ways," he said.
Mr. Dederick cautioned that the nation's economy "may be falling into its old boom-anddoom ways," jeopardizing the central bank's growth and inflation goals.
But he did not predict the beginning of a recession next year. As he sees 1995 : growth slows, but not dramatically; inflation steepens, but only gradually; and interest rates climb, but not alarmingly.
In short, he said, "the Fed's speed limit for the economy has been broken, but not to the point that the expansion in pulled off the road," the economist said.
"Nonetheless", he said, "the risks are rising that once again the landing will be more hard than soft."
Mr. von Pentz said the financial markets are right to be preoccupied with interest rates while there is such uncertainty about business conditions.
Currently, he said, "there is a tug of war between good earnings and higher rates." That can go on for some time, he said, but the impact of rates wins out and corporate profits flatten out.
Mr. yon Pentz thinks eamings will continue rising during this quarter and the first quarter, but then level off. At that point, bonds will be more attractive than stocks, sparking a bond market rally that should also help bank stocks.
Riggs Management currently has about $12 million in shares among three major banks: Citicorp, Wells Fargo & Co. and Fleet Financial Group.
The firm also owns stock in selected regional banks, but it has considerably lightened holdings in this category because Mr. von Pentz doubts that prospective mergers and acquisitions are a strong basis for buying stocks.
"From an investor standpoint it's like throwing darts, it's just random," he said. "You can identify a whole lot of banks as potential acquisition candidates and never make a nickel in them."
In the Middle Atlantic region. he noted, "there are banks that have been mentioned as acquisition targets for seven or eight years. It can be a long wait. and a lot can happen before lightning strikes. It's a tough way to make money."
Moreover, he said, the deals that do occur "are not always a rational economic process." They may be governed by priorities of management that are not necessarily beneficial to the shareholders.
In picking stocks, Mr. yon Pentz relies on an investment model that stresses four factors: low price-to-earning ratio, strong earnings, positive revisions by analysts of earnings forecasts, and stock price momentum.
The two most important factors in successful investing, as he sees it, are value and trend. Right now, banks as well as bonds have value but lack momentum.
Mr. yon Pentz thinks the growth trend in banking industry earnings peaked during the second quarter. Owning them now, he said, involves picking those companies with the "ability to maintain earnings while fighting a compressing spread."
"We own Citi because they are doing a super job on the top line, revenues this quarter were great," he said.
"Wells Fargo had okay earnings, and it is buying lots of stock back," he noted. "Fleet is a cost cutting story."