What Time is It?
Flavor Flav, Public Enemy
Investors in the US stock markets are asking themselves that very question about bank stocks these days (and if they’re not, they should be). Specifically, the big question we have been debating around here is whether this market is like April of 1993, or April of 1995. That’s an important question, as the quality of investment returns are a matter of not just price but time. Make 25% in a year and you look good. Make it in 5 years, and you look not so good. Not looking so good is usually a good way to find yourself in a different line of work. So let’s get the time part right if we can.
Look at the long term chart below of the KBW Bank Index (BKX) – it’s a 20 year, monthly chart. The BKX is made up of the 24 largest banks in the country. As you can see way on the left, beginning in October of 1992 the BKX made a nice move from the low 20s to almost 30 by April of 1993. This was about a 30% move in 6 months. This was good. Then the BKX went sideways for 2 years. This was not good, and a lot of investors who missed the first move gave up waiting for the second leg to start. The selloff in the fall of 1994 from 30ish to the mid-20s was particularly dispiriting, and was based on the false premise that rising interest rates were going to hurt bank income (it only hurt thrifts like Washington Mutual, which failed in 2008).
I worked at Keefe, Bruyette & Woods at the time as a research analyst (and yes, I used to calculate the BKX once a day, by hand), and can remember the frustrations of our Director of Research, David Berry, when he would try to get a client to see the value in Chase at 5x earnings, or Citibank (C) at 4.5x, or Bankers Trust at 4x. No one cared.
History Doesn’t Always Repeat Itself, but it Does Rhyme
But, despite the gloom, things were beginning to get better. Were they great? No. There were still a lot of expenses from operating real estate that banks had foreclosed on (OREO expenses) (just like today) and people were still afraid to buy banks after the near-death experience of the early 1990s (just like today). But then things stopped getting worse, and started getting better. OREO expenses started coming down, which boosted earnings. Net interest income started going up as banks raised rates charged on loans, but lagged in raising them on deposits. Simply put, things went from bad to better. And that’s where the money is made.
Look at the chart again. If we are in 1995 mode, this move could just be getting started. Back then, large mutual funds and other long-only investors who “didn’t believe” in 1994 were buying banks every day in 1995, 1996, 1997. Could we have a sell-off from here? Of course – we can always have a sell-off. Manage your risk, and don’t make bets you can’t afford to lose. But if we do have a sell-off, that will probably be a great buying opportunity for US banks (and let me be clear – I mean ONLY US banks – don’t go buying European banks just yet. Portugal and Spain still have some “voluntary haircutting” to do over there first.) But someday soon, I’m thinking that the dual earnings tailwinds of higher interest rates and lower credit costs will propel bank earnings higher, and the stocks will likely follow.
For full disclosure, in the funds I manage we bought a basket of financials in mid-March. They were American International Group (AIG), Blackstone (BX), Keycorp (KEY), Capital One (COF), SunTrust Inc (STI), Synovus (SNV), and Wells Fargo (WFC). We already owned some others. While I own them now, positions can change at any moment.
S&P 500 (SPX) Support and Resistance Levels:
Support: 1390/1392, a little at 1385, then lots at 1375.
Resistance: 1401, 1404/1406, 1411/1413, 1418/1420 then not much above that.
Positions: American International Group (AIG), Blackstone (BX), Keycorp (KEY), Capital One (COF), SunTrust Inc (STI), Synovus (SNV), and Wells Fargo (WFC)
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Reproduced with the permission of Jeffrey Miller.
Jeffrey Miller has successfully managed hedge funds and mutual funds since 1997. He was recognized as one of the “20 Rising Stars of Mutual Funds” in Institutional Investor’s January 2008 issue. He currently manages a 5-Star Morningstar rated equity mutual fund, was named a "Category King" for Large Cap Value Funds by the Wall Street Journal for 5 straight months in 2008, and was named Number 1 in its peer group, the Large-Cap Value Funds category, as tracked by Lipper, a Reuters Company, for the three-year and ten-year periods ended July 31, 2010. Currently his fund is the only Large Cap Core fund to have beaten the S&P 500 for 11 years in a row. He is the author of Miller's Market Musings.