The rally in the bank stocks sputtered last week, but it didn't seem to bother Wall Street. Indeed a sigh of relief could be heard as the stocks' momentum slowed.
"Financial stocks have been the most spectacular part of this market," said Hugh Johnson, chief investment officer of First Albany Corp. "There may be a 5% to 10% correction, and then maybe we can get some sobriety back into this market."
On Thursday, bank stocks followed as the Dow Jones industrial average retreated 92.75 points to 6927.38. And not surprisingly, the bigger the bank, the harder it fell.
As the Standard & Poor's bank index fell 9.3 points to 523.85. Wells Fargo & Co. lost $5.37, Citicorp $4.12, BankAmerica Corp. $3.25, and Chase Manhattan Corp. $1.87.
They recovered Friday. The S&P Bank index rose one-fifth of a point to 524.05, with Wells gaining $2.25 to $310.375, BankAmerica 25 cents to $118, Citicorp 75 cents to $121.625, and Chase 25 cents to $102.50.
Even so, skeptics doubt that banks can keep trading at 14 times earnings estimates on average.
"The bank group's current relative earnings strength appears to be slipping," Natwest Securities analyst Thomas McCandless said in a research report.
"The market will be faced with year-over-year earnings per share growth of 6% to 8%; not the current 12% to 14% embedded in current expectations."
Analyst Brian Eisenbarth of Collins & Co. in San Francisco agreed. While there is some upside left in the stocks, he said, "there's so much expectation priced into the S&P 500, that it's not going take much to derail these stocks."
Some observers blamed the bond market for cooling off the bank stocks. When reassuring news on inflation Wednesday failed to evoke a reaction from the bond market, stock buyers surmised that the decline in longer-term interest rates may be coming to an end.
The yield on the 30-year Treasury bond may be coming back towards 6.785%, Mr. Johnson said. It stood at 6.64% Friday afternoon.
Mr. Eisenbarth agreed that the bond market is the "driving force" behind the banking sector.
"As soon as the bond market goes flat or down, its going to become more difficult for earnings multiples at money-center banks to expand," he said
Mr. McCandless said that the 100-basis-point difference between bank earnings yields and the 10-year Treasury bond is not "intuitively" rich enough to entice investors, given the added risk level of bank stocks.
If 10-year Treasuries yield 7% one year from now, bank investors could lose 15% to 20%, he said.
Observers said that the smaller bank stocks may not be as vulnerable as the money-center stocks to broader market pressures.
Analyst Steve Didion of Hoefer & Arnett, San Francisco, said that stocks of smaller banks aren't as vulnerable to moves in the broader market since they're less liquid, and unaffected by program trading.
"Small-cap banks are cheaper, so they have tended to rise and fall more slowly over the last few cycles," Mr. Didion said. "Though it takes less to hurt them, they're still behind in the bank rally, and we're still excited about them."