NEW YORK ( TheStreet) -- Financial stocks have rallied lately. During the past year, financial funds returned 33.3%, compared with 24.8% for the S&P 500, according to Morningstar. Can the gains continue? Some fund managers think so. They argue that banks have remained undervalued since the financial crisis unnerved investors.
Banks typically sell for 80% to 180% of their book value -- the assets minus liabilities. At the depths of the financial crisis, prices dipped to near 50% of book values. Since then, the shares have recovered to 110%. That price appears to be cheap at a time when the S&P 500 commands 220% of book.
Make no mistake, many banks remain troubled. With the economy still sluggish, earnings growth is weak. But fund managers argue that the outlook is improving.
"As the economy strengthens, bank earnings will rise, and you will get up to the higher stock valuations," says Peter Kovalski, portfolio manager of Alpine Financial Services (ADAFX).David Ellison, portfolio manager of Hennessy Large Cap Financial (HLFNX), says that the current market reminds him of the banking cycle that occurred from 1987 through 1991. At the time, banks weakened their standards, making loans to shaky borrowers. What followed was a wave of defaults that caused dozens of institutions to collapse. Then pressured by regulators, banks began making sound loans. "After the down cycle, the banks all got religion," Ellison recalled.