This Wrongheaded View on the Stress Tests

 | Mar 13, 2012 | 6:25 AM EDT  | Comments
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aec

The word is out: The stress tests will be bad for the banks. I couldn't disagree more with that. I think the Federal Reserve is more than willing to accept that most banks have done the right thing and raised enough cash and can begin to pay out more money to shareholders.

I think what the Fed is torn about isn't the balance sheets of the banks. It's that they want more of the cash to be lent than what's returned to shareholders. The Fed sees how hard it is to get a mortgage, how little construction loan money is available and how high reserves are for all but the very worst banks, and it just doesn't know what to do.

In fact, I think the Fed's really only worried about Bank of America (BAC) on the big side and Regions (RF) on the small, although it keeps coming up that SunTrust (STI), a stock we just started buying for our Action Alerts PLUS portfolio, needs more capital. Note to bears: If that is the case, then you'd better cover on the secondary -- because I think, while Atlanta homes keep sinking in value, the larger region's strength is growing evident.

In the last few months I have had the CEOs of shopping-mall real estate investment trusts, outlet REITs, shopping-center REITs, office REITs, hotel REITs and apartment REITs. Do you know that not one of these companies has any new construction of any magnitude at all going on, neither within its company nor within their regions? Last night on Mad Money, I spoke with Jeffrey Friedman, CEO of Associated Estates Realty (AEC), an apartment-building REIT with 14,000 units in Georgia, Indiana, Ohio, Maryland, Florida, Michigan, Texas and Virginia. He said there has been virtually no new rental apartment construction, even as he's been raising rates consistently on his properties.

That's staggering.

That means, whatever's out there is most likely current on its bills to the banks, or it can be sold. At the same time, though, it says banks aren't lending enough to developers who would most likely want to take advantage of those high rents and meet demand with apartments.

I think the stress tests are far less about dividends and far more about giving banks the word that they are now safe to lend without the regulators coming down on them, and that they can take their payouts up a bit, too. I don't see this as a punitive exercise at all. That's why Monday's financial underperformance seems to wrongheaded to me.

A different, more positive takeaway could surprise us and take this group back up to the leadership status we need if this market is going to break through these crucial technical levels. Without the banks, a credible advance will not occur. There are just too many other groups, notably the Chinese cohort and the transports, that are holding the market back. Thursday's decision day could be the break the market needs, not the break in the group that so many are now expecting.

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