Doug Kass: How Did Bank Stock Investors Get So Clueless?

Travelling with the herd is often harmful to your investment well being. 
Banks stocks have been among the worst-performing sectors in the last six months. Yet, the vast consensus view was that, in a rising interest rate environment, seen in the last three months, bank stocks would be among the leading market performers.
The share price of the largest and most popular money center bank extant, JPMorgan Chase  ( JPM) , has fallen from $170 to $127.
Citigroup ( C) shares, a favored “value play” among the banks, has dropped from $79 to $50.
Among the better-performing large money banks, even Bank of America ( BAC) ($50 to $39) and Wells Fargo ( WFC) ($60 to $48) have performed poorly.
I attribute the mistaken and almost universal optimism towards bank stocks as a singular reflection of the superficiality of investors today (the near universal mantra that “rates rise and so will bank stocks”) and the mindless and wrong-footed logic and poor (company-specific and industry) analysis.
Bank stock investors have missed eight important headwinds to bank stock performance and banking industry profitability.
Indeed, bank stocks remain “full on Monet” from the movie Clueless: “It’s like a painting, see. From far away it’s okay, but up close it’s a big ol’ mess.”
1. What has been lost on bank-stock investors is that over history, while bank earnings do well with rising interest rates (as net interest income climbs), it is normally bad for bank stocks and the U.S. economy — as rising rates, especially when that rise is as extreme as since February, presage economic weakness and a reversal of the favorable banking trends (read: reduced credit demand, slowing economic growth).

2. Bank investors failed to recognize that banking is increasingly a competitive business that is being commoditized. The threat of non-bank financials and inflation is keen — both of which have served to raise technology costs and general expenses at a time when many of the business lines’ profitability is contracting under the constant pressure of competition.

3. Bank investors failed to understand how a rise in interest rates would adversely impact the marks to market on “securities held for sale” and, in turn, capital ratios — which will likely limit company buybacks . (See quote at the beginning of this column on JPMorgan’s reduced Tier 1 capital ratio in the quarter.)

4. Bank investors failed to remember that the world has grown more flat economically and that, like in a game of dominos, lending around the world can be treacherous and victims of outlier events (read: Russia).

5. Bank investors failed to understand how quickly investment banking revenues/profits can evaporate.

6. Bank investors failed to calculate the impact of a quick cyclical turn in investment management fees (lower bond and stock prices) and in reduced capital market activity.

7. Bank investors failed to recognize that the credit cycle can turn quickly.

8. Bank investors failed to identify that some bank managements (like Citigroup) can become victims of empire building and expanding geographical presence, at the expense of profitability and capital positions.

Here are several recent columns that I have written which have outlined my consistent concerns regarding bank stocks. 

(This commentary originally appeared on Real Money Pro on April 14. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass’s Daily Diary and columns from Paul Price, Bret Jensen and others.)

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