We Can't Break Out Without the Banks

 | Oct 17, 2011 | 1:11 PM EDT
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You are not going to be able to break out of this range unless you have the financials rowing with you instead of against you. They are way too big a part of the S&P 500, and they are a most severe millstone around the average's neck.

Lots of times people ask me what would change my mind about the financials, what would make me more bullish, particularly after JPMorgan (JPM) and Citigroup (C) topped estimates and Wells Fargo (WFC) equaled them -- nothing too shabby, considering the circumstances.

Here's my answer: revenue growth. We need to see not bottom-line satisfaction but a sense that these companies can grow revenue that will subsequently lead to earnings increases.

We are not getting that at all. The earnings you see tend to be a function of a reversal of loan losses. The revenues are roughly about where they were earlier this year. Worse, the actual businesses seem to be in decline. I am seeing a downtick, for example, in investment banking. I am also seeing deterioration in home equity loan losses.

Not only that, but we are in a perilous moment when it comes to the two most important sources of income: fee growth and net interest margin. Ever since the president and Senator Dick Durbin from Illinois took potshots at Bank of America (BAC) for raising debit fees, you know that any fee augmentation is going to be met with a barrage of bad publicity. The hit to earnings from credit card rules, orchestrated by Durbin, is gigantic, as much as a billion for JPMorgan alone.

Meanwhile, the Federal Reserve, in a so-far vain attempt to get the federal government to leverage low rates to get underwater borrowers to refinance, has put a real crimp in the amount that a bank can charge for loans vs. what it costs to borrow. That net interest margin line is shrinking, and there is not much to take its place.

Given all of that, and an anti-bank climate that is worse than at any time I have ever seen in my life, this group has become a must-avoid. That's terrible news, given the losses that funds are sitting on with these stocks, particularly those like the funds run by John Paulson and Bruce Berkowitz.

I think this group cannot turn any time this year. That means there has to be dramatic breakouts from lots of other important areas, including oil and gas, tech, industrials, utilities and retail.

That's a tall order. And we are not even talking about the impact of Europe's problems on America, particularly the banking group. That's why I continue to believe we are range bound, and when we hit the top of the range as we did last week, it was a terrific time to take profits and see the market's next step, which is likely to be, as we see today, a problematic one.



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