The Fed sounded the all clear for most major U.S. banks, and its stress test results could be positive for stocks Wednesday, even though four of the 19 institutions failed.
J.P. Morgan fired up a major rally in bank shares and the stock market in the final hour of trading Tuesday when it announced, ahead of the Fed’s release, that it was raising its dividend by five cents and buying back $15 billion in stock.
The Fed was to have reported stress test results Thursday afternoon but moved up the release to 4:30 p.m. Tuesday due to concerns about the information getting out early. A senior Fed official said the J.P. Morgan release was not the cause, and the timing of the J.P. Morgan release was due to a miscommunication with the Fed.
“I would suspect there’s some follow through that would be good follow through, to this, not negative. I think it’s going to be on balance positive but what I’d like to see is banks (stocks) going their own way and not highly correlated here. That’s a sign that the system is normalizing,” said Barry Knapp, head of equity portfolio strategy at Barclays.
Citigroup , Met Life , Ally Financial and Suntrust all failed the test, which put bank balance sheets through a rigorous test simulating harsh financial conditions and unemployment of 13 percent.
Citigroup said without the capital actions it proposed, it would have passed the Fed’s test, and the Fed did not request a change to its current dividend policy. Citi lost 3.5 percent after hours.
“This is a hypothetical scenario so it’s not the end of the world,” said David Trone of JMP Securities on “Closing Bell.” “I think the stock is down in the aftermarket here because people were hoping for a bigger return on Citi.”
The Fed created stressful conditions that assumed 13 percent unemployment and a 50 percent stock market decline.
“On balance, you look at this as further confirmation that the banking system is very well capitalized and has improved their liquidity profile, but does that mean they’ll be good investments going forward? I don’t know. I’m still not there yet,” said Knapp.
“This is not what people thought in the fourth quarter of last year when they still thought a European crisis could be a contagion event for U.S. banks,” he added.
The Fed found under the harsh conditions of its test that the aggregate Tier 1 capital level for the group of banks would fall to 6.3 percent in the fourth quarter of 2013, from 10.2 percent in the third quarter of 2011. That was even with all the planned capital moves of the institutions, including dividends and buybacks. Tier 1 capital is an important measure of bank health.
The Fed said 15 of the banks were also able to maintain capital ratios above all four of the regulatory minimum levels even with their planned capital distributions. The Fed announcement was accompanied by a flurry of dividend and buyback announcements.
“I don’t know if we’re going to be back to the races like we thought we’d see at the end of the day. Now it’s tempered,” because of the failures, said Pete McCorry, who trades bank stocks at Keefe Bruyette.
The financial sector is still underweight in many portfolios, and major investors have been waiting to step back into the group. The S&P financial sector was up 3.9 percent Tuesday, and as of Tuesday was besting tech as the top performing sector year-to-date.
“The pace on the desk at the end of the day was greater than we’ve seen any time this year,” said McCorry.
After the actual Fed release, “it went from a correlation trade to the haves and have nots,” McCorry said.
The stock market Tuesday had its best day since December, with the Dow up 217 at 13,177 and the S&P 500 up 24 at 1,395. The Nasdaq jumped 56 to 3,039, its first close above 3,000 in 12 years.
The market was also helped by a positive retail sales number, up 1.1 percent. While in line with expectations, the number showed a more solid consumer spending on clothing and cars even as gasoline prices rose. Several economists notched up their GDP forecasts as a result.
Goldman economists said first quarter GDP is now tracking at 2 percent, up from 1.8 percent.
Separately, the Fed had a regular FOMC meeting Tuesday and in its post meeting statement, it upgraded its economic forecast, using the term moderate instead of modest growth.
“They still kept the phrase ‘significant downside risk,’” said Goldman Sachs economist Andrew Tilton. “If you step back from that, they are seeing more growth, but in many ways they are still seeing it as moderate growth.”
“They’re seeing inflation subdued… they’re very worried about financial risk. The overall message is still quite cautious and still very much leaves the door open. It’s very much noncommittal but QE (quantitative easing) is still on the table,” Tilton said.
What to Watch
At 10 a.m. ET Wednesday, Fed Chairman Ben Bernanke speaks to the Independent Community Bankers of America national Convention.
Import prices and the fourth quarter current account are released at 8:30 a.m.
The Treasury auctions $13 billion in 30-year bonds at 1 p.m.
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