Broker-Dealer Stocks Suggesting a Summer Surprise?

by Michael A. Gayed | June 25, 2012 9:52 am

“The investor of today does not profit from yesterday’s growth.” — Warren Buffett

Back in March, I discussed the prospect of money getting excited about stocks again[1] since the Dow Jones Industrial Average (DIA) had just crossed 13,000. Bond yields (TLT) were beginning to rise, and we were in the midst of one of the best first quarters for equities in a long time.

I looked at the price ratio of the iShares Dow Jones U.S. Broker-Dealers ETF (NYSE:IAI[2]) relative to the DIA and made the case that outperformance in these stocks meant that “money is betting on activity returning to the financial sector, with a lot more room for the ratio to run higher.”

By the start of April, that trend reversed. This was around the time that I began arguing for the odds of a mini-correction. Take a look below at the update price ratio. As a reminder, a rising price ratio means the numerator/IAI is outperforming (up more/down less) the denominator/DIA.
Click to Enlarge

Notice how sharply IAI began underperforming DIA in April, before the May breakdown in risk assets and before one of the worst outflows for equities in years. This occurred in the face of relatively stable U.S. stock prices.

Now, the ratio appears to be bottoming out once again. I believe the odds are very high for a comeback, particularly given the most recent slew of bank downgrades, which in reality did not have much of an impact on broker-dealer stock prices.

The implication? Following the summer crash of 2011, fall melt-up, winter resolution, and spring switch, I believe we are going to have a summer surprise, whereby reflation persists and we see an end to the “end of the world” trading that has sent financials diving relative to equities at levels unjustified in the face of better fundamentals and a gradually improving economy. Should the stocks of investment services recover, that would confirm that markets have much more to run on the upside than most observers might normally think.

  1. I discussed the prospect of money getting excited about stocks again:
  2. IAI:

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