Investing in America, Betting on Banks

A bet on banks is a bet on the U.S. economy. The reasons are pretty simple, banks are levered to the economy through their exposure to big and small businesses, real estate and the consumer.


Improvements in any of these areas can easily translate into better results for banks various businesses including commercial and industrial loans, small business loans, credit cards and mortgages. Still, with this group outperforming over the last three months, are investors late to the trade?

Not yet, if you know where to look, according to analysts and money managers. This is key for investors who have stood by and watched the KBW Bank Index rack up a 26 percent gain over the last three months, more than double the 12 percent return delivered by the S&P 500 index.

While bank stocks are now reflecting the healthier balance sheets of the nation’s banks, Jefferson Harralson, a managing director at Keefe, Bruyette and Woods wrote in an email to CNBC, the run in bank stocks reflect investors betting on a turnaround in the U.S. real estate market.

“In other words,” he wrote, “Some turnaround in real estate is already priced in.”

For bank stocks to move another leg higher Harralson says real estate has to improve more than expected and loan growth and balance sheet growth would have to accelerate at the banks. It is a situation he says could happen because the economic environment is getting better. As for which bank stocks would perform better in a strengthening recovery, Jefferson wrote it is the banks that fared the worst during the downturn.

“The rising tide lifts all boats,” he wrote. “Just the biggest beneficiaries are those boats stuck on a sandbar.”

To that end Harralson writes buying banks in distressed regions of the country, like Florida, is a way to play the recovery. Within the state, the smaller banks should outperform the larger ones as the recovery takes hold. Another riskier bet, but one offering the potential for greater reward, would be to invest in banks that are less profitable or those that have yet to repay TARP money — the loans they received from the government during the financial crisis. A stronger economy not only increases these banks chances for higher profits, but the chances they will be able to shed the negative TARP mantle and give a lift to their share prices.

Richard Bernstein of Bernstein Global Management is underweight financials, but says banks could be on the cusp of a new upward cycle. Like Harralson he sees the greatest potential reward coming from investing in the riskiest banks, but that is not his type of investment. Instead he said as the recovery takes hold and the rebound in real estate becomes a reality, he is looking to add to select positions. Among them, some of the money center banks like Wells Fargo , Bank of America and Citigroup . In addition, some of the $475 million he manages might be used to add to holdings in smaller banks in well-to-do communities. He likes these stocks because the banks are in solid local economies which should benefit as the national economy gains momentum. Among his favorites Brookline Bancorp of Brookline, Massachusetts, Paramus, NJ based Hudson City Bancorpand Maine’s Bar Harbor Bankshares. Less risky plays, but a safer way to play a still uncertain recovery.

Follow Mary Thompson on Twitter: @MThompsonCNBC