By JACK HOUGH
Bank stocks have led the U.S. market this year. There's reason to believe they have further to run.
The KBW Bank index, which tracks global money centers like Citigroup (C)
Much of the outperformance occurred since June on steps by euro-zone leaders to address a government debt crisis. The head of the European Central Bank committed in July to "whatever it takes" to save the euro. This month, a key German court backed the creation of a permanent bank rescue fund and the European Commission took early steps toward forming a banking union.
This boosted U.S. banks in two ways. First, fears eased that they will be dragged into a European banking crisis, raising investor confidence in the sector.
Second, the 10-year Treasury yield, which sunk below 1.5% in July in a sign of investor gloom, recently topped 1.8%. The one-year yield is little changed over the same period. In Wall Street parlance, "the yield curve has steepened." That's good for banks, because short-term yields are representative of rates banks pay to depositors, while long-term ones are linked to rates they charge to borrowers.
In a Monday report, technical analysts at Bank of America Merrill Lynch (BAC)
The effectiveness of such easing on the economy is open to debate, but BofA points out that it has worked a treat for bank shares. Following similar programs announced in mid-March 2009 and early November 2010, bank shares went on to rally more than 20%.
This time around, the bond-buying will focus on mortgage securities, which could reduce mortgage rates and give those homeowners who haven't already refinanced reason to do so. That could raise profits for mortgage lenders. On the other hand, lower yields on mortgage securities mean banks that hold them will earn less investment income.
There are some other potential worries for banks. Chief among them, recent central bank actions are merely short-term efforts aimed at what could prove a long slog of slow economic growth, bringing meager profit growth for banks. That could make banks more of a short-term trade than a long-term holding.
That noted, most big U.S. banks trade at a fraction of the book value of their assets and have been writing off many of those assets whose values are questionable. That makes them look cheap relative to other stock market sectors. The financial and energy sectors are the least expensive in Standard & Poor's 500-stock index, trading at 12 times projected 2012 earnings. The index trades at 14 times earnings.
Financials, some of which had to cut their dividends during the 2008 global financial crisis, are also leading other sectors this year in the number of dividend increases.
Investors can place a broad bet on banks using PowerShares KBW Bank Portfolio (KBWB),