Analyst Frank R. DeSantis Jr. of Donaldson, Lufkin & Jenrette Securities Corp. downgraded J.P. Morgan & Co. on Tuesday, warning that the current bond rally, unlike its late-1993 predecessor, would not boost the money- center's return on equity.
He lowered his investment rating to "market performance" from "outperform," and said not to buy the shares again unless they fell below $70 a share. The stock closed down $1.625 Tuesday at $72.50.
The action follows two upgrades of the bank on Monday by analysts who argued just the opposite: The surge in bond prices will lift Morgan's shares.
George M. Salem of Gerard Klauer Mattison & Co. and Lawrence Vitale of Bear, Stearns & Co. said Morgan's balance sheet was well positioned to benefit from falling rates.
But Mr. DeSantis said that because there is an inverted yield relationship between the fed funds rate and two-year Treasuries, the bank would not enjoy the margin yields it did in 1993, when there was a wide disparity between the two rates.
"The situation today is much different with a negative carry between fed funds and the two-year treasury and an absence of leveraged derivatives," he said. "The situation will not support a 22% ROE like Morgan earned in 1993."
And the analyst predicted rates would rise again as soon as a bullish economic indicator was released, "calling into question the inevitable future decline in short-term interest rates."
But Mr. Salem argued the inverted yield curve would last only until July 6, when many observers expect the Federal Reserve to cut interest rates.
Theoretically, were the inverted yield curve to persist, then bank profitability could erode, he added.
In addition to Morgan, Mr. Salem raised his ratings on Citicorp and Chase Manhattan Corp. to "buy" from "hold" He also upgraded Bankers Trust New York Corp. to "hold" from "sell."
The severe interest rates declines, caused by a negative jobless claims report released last Friday, should convince portfolio managers to move their holdings into banks and away from industrials, which would be hurt in a recession, he said.
Banks have already enjoyed a 28% increase to date this year, but Mr. Salem said another 20% may be on the horizon. And, he added, money-centers should benefit greatly because of their large trading operations, which do well in a low-interest-rate environment.
And Morgan is the purest play, he continued, because it does not own a retail franchise. Repricing of deposits will not occur as quickly as some money market liabilities, Mr. Salem explained.
Similarly, Mr. Vitale of Bear, Stearns likes Morgan because as a wholesale bank, it is a great tool to play the rate rally.
"The regional banks as a group will not benefit significantly (or, in some cases, at all) from the falling rates, since as a group their funding costs are still rising," he said.
"Furthermore, if the economy is indeed headed into a recession, credit quality concerns will hinder the performance of the regional banks," he added. "In contrast, second-quarter results will show that Morgan has benefited from the lower rate environment and is not susceptible to credit- related concerns."
As a result, Mr. Vitale predicted Morgan could trade up to $90 in the next year, a 24% improvement from Tuesday's close.
The analyst does caution that Morgan could stumble on its cost-cutting initiatives. And cuts in pay could mean a brain-drain as competitors hire away talent, he said.
Mr. Vitale also speculates that if Morgan has taken a conservative position in bonds to reduce risk, performance may not be as bright.
Bank stocks fared poorly Tuesday as investors shifted to profit taking after several days of advances. The Standard & Poor's index of banks fell .86% while the overall S&P declined only .01%.
But BayBanks Inc. bucked the trend and rose $1.50 to $74.50. The Boston- based bank's stock had fallen $3.75 per share Friday after denying press reports it was going to be sold to a Canadian bank, but shares have since risen.
Golden West Financial Corp. fell $1 to $48 after Sanford C. Bernstein & Co. downgraded its stock to "market perform" from "outperform" on price.
Golden West's earnings recovery is already factored into the stock, the firm said in a research report. Echoing last week's recommendation by Salomon Brothers Inc., Bernstein's report said H.F. Ahmanson, another California thrift company, is a better investment.
