Banks Give Investors What They Want

 | Nov 26, 2013 | 1:06 PM EST
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Maybe it was always about certainty and yield curve, not about housing.

I am talking about the breakout move by the banks here and how they have been able to rally silently, without a lot of fanfare, not on more robust housing data, but on an understanding that the prosecutions are indeed winding down. That, plus the fact that the yield curve (the rates bonds pay as you go out in time) is, at last, giving these companies a hefty and regular profit. The banks pay you the same rates on your CDs that you got paid before rates increased, but they can invest your deposits with a much greater return than before.  

The spread is at last so bountiful, and getting more so as interest rates creep up and CD rates stay exactly where they are, that I think it almost has to show up in next quarter's earnings. That's right, I think banks will beat the estimates and their stocks will continue to rally.

Investors love nothing more than a risk-free earnings stream and that's what this disparity between the CD rates and the Treasury rates gives them. It also doesn't hurt that there have been endless fee increases, giving banks a terrific source of regular profits.

But perhaps the most important reason for this bank rally is certainty, the certainty that we are, at last, in wind-down mode for the prosecutions. How do we know that? Because Stephen Cutler, the general counsel of JPMorgan Chase (JPM), went public yesterday, criticizing the government, asking when are the prosecutions and persecutions going to end. You don't risk asking that question unless you are already pretty close to the end zones. You would be afraid to do so otherwise.

A big earnings stream like the CD transference, as great as it is, doesn't matter if there is no certainty to the legal regime for these banks. As long as there are threats of big prosecutions, there are going to be worries that the interest-spread bonanza doesn't matter.

JPM and, to a lesser extent, Wells Fargo (WFC) and Citigroup (C) are benefitting from the perceived endgame. The decline in prosecutions following the huge $13 billion JP Morgan settlement can and has been moving the entire group because these stocks trade together regardless of how different their businesses are, and they are very different.

Wells Fargo is a gigantic housing play, with some 30% of the mortgage market and a halo effect from Warren Buffett. Citigroup is an emerging-market dog with an American tail. JP Morgan is a tremendous investment bank with a terrific, stable deposit base. Yet they are total lock-steppers, all.

Today we have a nice housing rally off of old Case-Schiller data, as stale as the day it was canned, showing that home prices since September have, according to that national index, risen the most since 2006. Of course we now have October data not captured by that index, something that makes it so flawed as to be remarkable that it has any impact at all, because from the perspective of every kind of current housing data available, October was a very weak month, the first one where the higher rates played a role in slowing down purchasing and cooling pricing. I say the rally will be short-lived as the stocks are still expensive on 2013 earnings.

As we can now see, there's not much of a rally at all in the bank stocks off the homebuilding surge. That's because we now know the bank stocks aren't really about housing. They are about governmental certainty and the yield curve.  

So, I think this time the bank rally -- not the homebuilding rally -- has real staying power. The banks are giving investors what they wanted all along, not reserve reversals from housing coming back to life, but plain-old vanilla fees and returns on your deposits. And as rates go higher and the prosecutions are more in the rear view mirror this group, truly the last remaining cheap sector of the market, will catch up and become a leader as it so often does when rates allow them to make money simply by turning the lights on.

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