After Monday's sell-off, bank stocks roared back Tuesday despite new economic data that showed further deterioration in housing markets.
The KBW Bank Index surged 8.5%, more than making up for Monday's 4.5% skid.
"It's a very nice change," Joseph Morrissey, a bank stock trader at Boenning & Scattergood Inc., said in an interview Tuesday.
Notable gainers included Omni Financial Services Inc., 32%, Downey Financial Corp., 27.2%, East West Bancorp Inc., 16.7%, and Washington Mutual Inc., 12.4%.
Among large-cap companies, Wachovia Corp. rose 15.2%, Bank of America Corp. 14.8%, and Wells Fargo & Co. 9.1%.
B of A reclaimed the top spot in market value among banking companies, bumping JPMorgan Chase & Co. to No. 2. Wells leapfrogged Citigroup Inc. to take the No. 3 spot. This happened despite strong trading sessions for all four companies.
JPMorgan Chase's shares rose 8.2% Tuesday and Citi's rose 5.9%.
Mr. Morrissey said strength in financials, coupled with falling oil prices, lifted the broader markets.
The Dow Jones industrial average rose 2.4% Tuesday and the Standard & Poor's 500 gained 2.3%.
But Mr. Morrissey said broad economic concerns continue to weigh on the markets — and financials in particular.
"I personally think we're a little ahead of ourselves here," he said. "There's been a lot of short-covering" behind any notable gains made in recent weeks among bank stocks. "I think by no means is this going to be a V-shaped recovery. There is still pain to be felt in financials."
The S&P/Case-Shiller home-price index, released Tuesday, showed home prices fell in May in every region of the country. Housing prices in 10 major metropolitan areas dropped a record 16% from a year earlier. Miami and Las Vegas, which each reported 28% declines, were the two hardest-hit cities.
However, a handful of large markets showed resiliency. Boston, Charlotte, Dallas, and Denver each posted 1% increases from the previous month, indicating that buyers in at least some markets are dipping their toes back into housing.
The "national housing crisis is morphing into a series of regionalized crises," Jack A. Ablin, the chief investment officer at Bank of Montreal's Harris Private Bank in Chicago, wrote in a research note Tuesday.
However, Mr. Ablin wrote that investors have reason to be optimistic about the long term. Legislation approved by Congress last week gives "the Treasury authority to shore up Fannie Mae and Freddie Mac," and "first-time homebuyers, if there are any left, will be offered tax incentives to take the plunge."
Fannie rose 12.5% and Freddie 9.1% Tuesday.
Also, late Monday, Merrill Lynch & Co. Inc. said it would unload $30 billion of mortgage assets at a steep loss and issue $8.5 billion in stock to bolster capital levels. In a research note, David Hendler, an analyst at CreditSights Inc., called Merrill's move "a huge step in the right direction," and investors agreed on Tuesday.
Merrill's shares rose 7.9%.
American West Bancorp of Spokane, which this month reported a second-quarter loss, said Tuesday that its chief executive, Robert M. Daugherty, resigned at the request of the board and that the board appointed chief operating officer Patrick J. Rusnak as interim CEO.
Craig D. Eerkes, American West's chairman, said in a press release, "We are confident that our interim management team can move forward quickly with our plans to return to profitability and attract the necessary capital to ensure our company's long-term financial stability."
Investors weren't as sure. American West's shares plunged 28.2%.
Other decliners Tuesday included EuroBancshares Inc. of San Juan, Puerto Rico, 15.8%, and Heritage Financial Group of Albany, Ga., 7.3%.
