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Want a Rally? Put on Your Pompoms and Start Rooting for Banks

We can't have a lasting recovery without the financial sector

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Bank stocks and the financial sector have seen their share of ups and downs in the last three years — though decidedly more downs than ups.

On the retail banking side, Bank of America (NYSE:BAC) is off almost 85% since its 2008 peak, and Citigroup (NYSE:C) is down nearly 90% in the same period. On the investment banking side, Morgan Stanley (NYSE:MS) is off more than 60%, and Goldman Sachs (NYSE:GS) is off almost 45%. A host of other financial stocks, large and small, have felt similar pain.

It might seem like a natural reaction to wag your finger at the big banks, since these institutions got exactly what they deserved for their reckless role in the subprime mortgage meltdown. Actually, shaking your fist in anger may be more apt — since one can argue that “too big to fail” institutions got a pretty plush deal with a no-strings-attached bailout and executive compensation that boggles the mind.

But here’s the harsh reality of our current economic quagmire and the fragile rally on Wall Street: We simply can’t have a lasting recovery without the banks.

That’s why each and every investor out there should cheerlead for the financial sector — every day, for as long as it takes.

Otherwise, we are in for a very long and difficult road ahead of us.

Financials Hold Back the Market

We’ll get to some big-picture stuff in a second, but let’s start with the biggest reason investors should root for banks: cold, hard cash.

Simply put, when banks rally, the market rallies. And when banks crash, the markets crash. So unless you are going to go perpetually short, you want to see banks stabilize and start growing — fast.

A look at this chart shows the biggest one-day moves for the market this year on Aug. 8 and 9. The correlation between big moves for the market and big moves for the banks is clear — and bears itself out in less dramatic fashion across other volatile days in the market this year.

Admittedly, the big move on Monday, Aug. 8, had a lot to do with macro issues — the credit downgrade of the U.S. sparked the selloff. But as the headline of my column at the time read, the U.S. credit downgrade changed nothing. In fact, rates briefly dipped as low as 1.9% for the 10-year T-Note. It’s also worth noting these stocks have a lot of pull on the broader indices because BofA and JPMorgan Chase (NYSE:JPM) still are in the Dow, and the market-cap weighting of the S&P 500 Index means megabanks hold a lot of sway.

But all that aside, we should all agree that — generally speaking — sentiment was a bigger factor in August after the downgrade. And sentiment is what’s driving bank stocks, pure and simple, since accounting tricks at financial stocks make numbers difficult to trust.

Thanks to the power of fear or greed on this sector, as investors get bullish, they get into banks big-time. As they get bearish, they run screaming from financials.

In short, a rally in banks means a gush of market optimism — something that all investors should be in favor of.

Article printed from InvestorPlace Media,

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