One of my most out-of-consensus ideas at the moment is that regional banks stocks are on the verge of new swing higher. And that means it just might be crazy enough to come true. Sentiment is terrible: The February 2010 Fund Manager Survey ranked global bank stocks as the most underweighted sector by institutional investors. 

Sure, bank stocks have done well over the last few weeks: Since the February low, the Financial SPDR (XLF) has gained 13% compared to an 8.8% gain for the S&P 500. In fact, the XLF is now challenging its October high in an impressive show of strength and now threatens to move out of its long consolidation range. So can the gains continue, especially for sprightly regional banks like Keycorp (KEY) that are just now emerging from the wilderness after the 2007-2008 meltdown? 

There is certainly a good argument to be made. In fact, in its latest set of “actionable investment themes” sent to institutional clients, Merrill Lynch gave two big reasons to consider financial stocks as a long-term play. 

The first is that financials are “the best cyclical recovery play” according to the Merrill team. Why? Because bank earnings are expected to rebound strongly as loan loss reserves are satisfied and net interest margins benefit from ultra-low short-term interest rates and rising long-term interest rates — a phenomenon known as a “steep yield curve.” Financials should earn $20 billion in the current quarter according to the ML team, a figure that almost equal to the entire full-year loss in 2008. 

The second rationale behind the idea is the close historical relationship between retail stocks and bank stocks in the United States. I don’t need to remind you have strongly retail stocks have been performing lately, given the impressive 16% advance in the Retail SPDR (XRT) since the February low. I expect bank stocks to close the gap seen in the chart above — and will continue to recommend ways to profit from the trend.

In my advisory service Strategic Advantage, plays on this include iShares Regional Banks ETF (IAT) and SPDR Insurance ETF (KIE), which are up 7% in the past three weeks. I expect them to continue to be good solid holds through the rest of this year even if they encounter some strong turbulence along the way.

One factor that should give us a lot of hope for the longevity of this advance: Investors are not just bulling up the same old pack of big-cap techs and emerging market stocks that led last year’s advance. They have turned their attention to cheap companies in these formerly overlooked groups that have plenty of upside if they get the right attention — and moreover that deserve the new attention.

You just knew I was going to mention the real estate trusts, right? I have talked a lot about about Piedmont Office Realty (PDM), which had the good fortune to IPO right at the recent bottom in February; it yields 7.1% and has also advanced 30% in price. It’s a good buy on dips. Among much more mature REITs, there are many that are still 80% below their 2006-2007 highs, like Strategic Hotels (BEE) that are finding new buyers and breaking out from low single-digit levels.

Much the same story for CBL & Associates (CBL), Kite Realty Group (KRG), which still pay a 5% dividend; Glimcher Realty (GRT), charted above, which has paid steadily on an 8% yield; and First Industrial Realty (FR), which hasn’t reinstated its yield. Even the king of the shopping malls, Kimco (KIM), is on the move from its -65% perch. As long a retail continues to strengthen, these well-seasoned companies — many of which are still run by their founding families — will continue to catch a good bid.

For more ideas along these lines, check out my Trader’s Advantage newsletter.

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