With bank stocks on a roll, thanks to market expectations that the Federal Reserve will cut interest rates before Christmas, some analysts are advising caution.
Profit taking muted the advance Tuesday after a big rally for the sector on Monday, but many banks still registered gains.
The American Banker index of the nation's top 225 publicly traded banks was up 3.51% during the week ended Monday, versus a far smaller gain of 1.87% for the Standard & Poor's 500 stock index.
Among the analysts sounding a cautious note was Linda Stromberg of M.R. Beal & Co., New York. Ms. Stromberg anticipates a 10% to 15% correction in stocks overall soon, which would decrease the appeal of bank stocks.
"People have been nervous anyway about holding banks for their merger prospects," she said. "If stocks prices fall, mergers will not happen," and selling pressure could intensify.
Ms. Stromberg suspects that bank earnings in the months ahead may not be as strong as some investors now believe, and the resulting disappointment could start a downdraft in the stocks.
"As a rule, earnings of banks tend to hold up a little better in economic downturns than do other companies," noted Francis X. Suozzo of S.G. Warburg & Co. "So buying banks is typically seen as a good investment strategy if you are worried about a slowdown.
"When you have a strong stock market to begin with, and then bond yields drop 40 to 50 basis points, investors immediately look to financial stocks as a way to play off that development," the analyst said.
But Mr. Suozzo said he disagrees with the widely held perception that lower rates necessarily translate into faster earnings growth for banks.
Lower rates relieve some of the pressure on borrowers, which in turn alleviates Wall Street's anxieties about credit quality, Mr. Suozzo said.
But declining rates also put pressure on bank net interest margins, he noted, since it is likely that asset yields will fall faster than funding costs. Funding costs from banks' core deposits are already low and probably cannot be pushed down further.
Mr. Suozzo also argued that falling rates can actually increase credit risk, because they likely reflect a slowing economy. That can mean greater problem assets and credit losses.
Moreover, a slower economy means slower loan growth, he said. "And loan growth has been one of the engines of bank earnings growth this year."
The analyst said investors should be "neutrally weighted in the money- centers, favoring the companies with more visible earnings growth," such as First Chicago Corp., Chase Manhattan Corp., and Chemical Banking Corp.
Mr. Suozzo is more leery of large trading-oriented banks. He currently has a "reduce" rating on Bankers Trust New York Corp., where he expects disappointing earnings and a dividend cut.
The analyst is also negative on the outlook for regional banks and nonbank financial companies "because of greater risks to earnings from margin compression and faster-than-expected increases in loan loss provisions."
