Will The Rally In Financial Stocks Continue? Is It Important? Part One
This may be the most important and perplexing question about investing (not just equities) for the next year and possibly longer. The traditional point of view among professional money managers is that financials are early cycle stocks, and that you can’t have a sustainable bull market or a new bull market without the early and broad participation of money center and regional banks, consumer finance stocks and insurance companies. And to state the obvious it is these very stocks that have been a disastrous black hole for some of the best investors (like Bill Miller of Legg Mason) in the world for over a year now.
Over the last 3 months, six months and year to date the financial stocks have out performed the S&P 500, by hundreds of basis points over the last 3 and 6 months, by a percent and a half year to date. Many financial stocks are up quite strongly since the early March market lows, many beating the market overall by a large margin. Over the last 12 months the financials have underperformed the S&P by only about 2.5 percentage points.
The TED (3 month eurodollar rates over 3 month treasury bill rate) spread is making new lows, the three month LIBOR-OIS index stands at 63 basis points, its lowest since March, 2008. By these indices, trust is creeping back into the institutional money markets and the banking system. The pressure is starting to lift off the chest, and the feeling is maybe this will prove to be a minor heart attack in the long term life of the market.
But what changes are now creeping into the public policy lexicon? Important and far reaching terms like “narrow banking” and “limited purpose banking.” In some form these may be the new rules that the financial services industry has to play with. How will these new rules of the game affect future profitability and returns? These proposals could result in some parts of the financial moving to a full reserve banking instead of the current fractional reserved banking system that we have today. That would almost certainly mean lowered profit potential at some current institutions, capping rates of return. So perhaps the next bull market will not be lead, or lead only briefing by the financial stocks. Perhaps that traditional tell-tale will soon be removed. So that is the conundrum, the puzzle we are watching now.
