The results are in for the bank stress tests by the Federal Reserve, and they show, as I had expected, an improving banking sector that is more defensive to risk and much improved as far as their balance sheets, liability, and vulnerability to dire market conditions.
The banks were tested based on a worst-case scenario to see the impact on the bank stocks and their ability to handle a major financial crisis. The key assumptions include: the unemployment rate surging to 12.1% (read “What the Government Doesn’t Want You to Know About Jobs Creation”), a pullback in the equities market by over 50%, and home prices falling by over 20%. (Source: Board of Governors of the Federal Reserve System web site, last accessed March 18, 2013.)
The stress test resulted in 14 of the 18 banks passing with conditional approval given to The Goldman Sachs Group, Inc. (NYSE/GS) and JPMorgan Chase & Co. (NYSE/JPM); both have to deal with a few issues and submit new plans by September. Assuming approval, 16 of the 18 bank stocks will have passed the test, versus 15 of 19 in 2012 and well ahead of 2009, when half of the big banks failed. BB&T Corporation (NYSE/BBT) and Ally Financial failed.
“The nation’s largest bank holding companies have continued to improve their ability to withstand an extremely adverse hypothetical economic scenario and are collectively in a much stronger capital position than before the financial crisis,” says the Federal Reserve. (Source: Ibid.)
The results support my view that the banking sector is on the mend. Now we’ll see if some of the banks will be allowed to raise their dividends back to over two percent. If this should occur, we could see a corresponding rise in the demand for bank stocks.
The reality is that the bank stocks have provided excellent leadership this year.
Bank stocks are cutting down on the amount of risk that they are willing to take on. Goldman Sachs is now at a point where the potential loss that can occur from trading is at a seven-year low. The other major Wall Street banks are also seeing a reduction in their risk. (Source: LaCapra, L.T., “Goldman trims risk-taking to lowest level in 7 years,” Reuters, March 1, 2013.)
The major bank stocks all closed off 2012 near their respective 52-week highs and have started 2013 with a bang, with the KBW Bank Index up 11.7%, which is above the comparative return of the S&P 500 and the Dow. The attraction to the bank stocks has been driven by an improving banking industry that is assuming less risky businesses while shoring up their balance sheets and producing stronger units.
The chart of the Philadelphia Bank Index shows the upward move of bank stocks from their 2011 bottom. Bank stocks staged a nice rally, but retrenched in March–May 2012, on the European bank concerns and Moody’s Investor Services’ downgrade of the sector. The group has since staged a rally back above the 50- and 200-day moving averages (MAs), based on my technical analysis. But there was some topping on the charts, followed by the recent selling, as indicated by the blue circle on the chart below.
Chart courtesy of www.StockCharts.com
I feel there will be more gains ahead for bank stocks.
The reality is that the “Volcker Rule,” set in place by economist and ex-Fed Chairman Paul Volcker, appears to have worked to cap the speculative trades and risk banks are so willing to assume. Banks have altered the way they do business and have shown positive strides.
In my view, the operating results have been fairly good, and they indicate the banks are able to grow their business volume across the board during an economic recovery in the U.S.