From: Nicole Urken
Sent: Tuesday, January 17, 2012 8:30 AM
To: James Cramer
Subject: RE: Wells
We are seeing this today in Wells vs Citigroup!
The latest conundrum: The move in the much-hated bulge bracket banks. Case in point: On Wednesday, we saw Goldman Sachs rally 7 percent after posting better-than-expected earnings, even as uncertainty remains surrounding the company’s go-forward growth drivers and the European debt crisis. On the other hand, U.S. Bancorp—which is among the best-of-breed regional banks and lacks European exposure—was up only 1 percent on Wednesday after posting a positive report. We are seeing this performance dichotomy between the bulge bracket and regional banks again today with Bank of America and Morgan Stanley up nicely (despite ho-hum fundamentals) versus BB&T—another quality regional bank—experiencing muted price action after a solid quarter.
So what gives? The safer, regional banks report strong numbers and barely move while bulge bracket banks, with significant overhangs remaining, shoot up? Two key explanations:
First, investors are starting to see positive signs out of Europe, including strong Spanish and French bond auctions today. There is a feeling among many investors that while Europe is far from solved, it has backed away from disaster-zone territory. Of course, this remains to be seen—but because of this sentiment, many are searching for ‘beta’ (financial jargon for riskier names that can provide more upside). Names like JP Morgan and Goldman have more upside potential if we do see stabilization in Europe.
Second, valuation and expectations. To put it simply: With Goldman and the banks, valuation doesn’t matter… until it matters. All last year, the bull case for the banks was that they have been trading significantly (and unfairly) below their book value. Yet this argument simply hasn’t made a difference, as estimates continued to be cut, and European debt issues remained a macro overhang. However, with Goldman kicking off a series of bulge bracket positive earnings beats, the cheap valuation argument suddenly becomes a reason to buy these names. The bull case now? The quarterly beats mean the stocks are too cheap here. Same argument, but this time it’s moving the stocks. The only difference this time is the reported beats. If, for example, Goldman can perform decently in this environment, improvement in housing and jobs are a powerful combination for the stock and its peers, which have underperformed over the last four years… and this implies valuation is too cheap. In other words, again: valuation doesn’t matter… until it does. In contrast, best-of-breed regional U.S. Bancorp has been trading over 1x its book value and investors see less upside here, despite its solid positioning. Oh, not to mention that Goldman was down 46 percent in 2011 while U.S. Bancorp was flat.
All that said, the email exchange above with Cramer from the beginning of January does still reveal the improved positioning of regional-focused banks—where Wells Fargo is a winner. Wells, which posted a strong quarter, is a strong play on housing coming back, particularly given the many mortgages on its book (and given that its Wachovia portfolio is in a much better position than Bank of America’s Countrywide one—with the remaining legal overhangs). Citigroup earnings report on Tuesday wasn’t enough to prompt a ‘too cheap’ thesis—particularly versus stabilization in Wells that we saw. But the later beat at Goldman—and now Bank of America / Morgan Stanley too—was enough to fuel the group.