Bank Stock Investors Skeptical of Rally's Prospects

Many investors continue to focus on the strongest names.
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Sorry, but the rocket-fueled climb in bank stocks that has surprised everyone over the last couple of days is probably over.

Large banks took off this week after months of sinking lower and lower. But seasoned bank stock players are saying that it may be some time before the

ingredients for a lasting climb -- such as an end to the

Fed's

interest-rate hikes -- are in place. As a result, bank stock investors are buying only select names, and avoiding institutions that may struggle in a hostile economic environment.

The

KBW Bank Index

, which tracks 24 large bank stocks, jumped 17% over Wednesday and Thursday, the largest-ever two-day increase for the index, which was formed in 1992. This almighty move was definitely welcome: The KBW was more than 30% below its 52-week high on Tuesday. By early afternoon Friday, the index was off the high by 19%. (It was off 0.2% around midafternoon Friday.)

Cautionary Note

"I'm still being a little bit cautious," says Frank Barkocy, of New York-based

Keefe Managers

, a bank stock hedge fund. "The interest-rate environment is not going to change for a while." Barkocy, like many other investors, believes in well-known names like

Chase

(CMB)

,

Citigroup

(C) - Get Report

,

FleetBoston

(FBF)

and

Wells Fargo

(WFC) - Get Report

. But he's also keen on

BB&T

(BBT) - Get Report

and

Wachovia

(WB) - Get Report

. (Keefe Managers owns shares in all those banks.)

Banking on a Rally
Bank stocks' recent rebound earns little praise

Source: BigCharts

Barkocy has little confidence in troubled firms such as

Bank One

(ONE) - Get Report

,

First Security

(FSCO)

and

KeyCorp

(KEY) - Get Report

. (Keefe has no position in any of those banks' shares.)

"We may have a little lull," says Lanny Thorndike, a manager on the

(CENSX)

Century Shares Trust fund, which invests in financial stocks. "Like in any dead-cat bounce, both good and bad things go up." As well as Citi, Chase, Fleet and Wells, Thorndike is attracted by

J.P. Morgan

(JPM) - Get Report

. (His fund is long J.P. Morgan, Chase and Fleet and has no position in Citi or Wells.)

Unexcited

Jonathan Iseson, manager of Long Island-based

Bluewater Partners

, a hedge fund, isn't getting too excited by the bounce-back in bank stocks. He believes that many banks still could get hurt by difficulties in the mortgage market, and he thinks the strength of the last two days is partly due to market-related or technical factors. For example, Iseson thinks that a popular derivatives trade that had hedge funds long

Nasdaq

stocks and short the

S&P 500

(which has a lot of financial stocks) broke down this week.

And Iseson is now betting that banks will fall back. "I just bought a lot of puts

options that profit from the underlying stock's decline on

State Street

(STT) - Get Report

,

AIG

(AIG) - Get Report

, Wachovia,

SunTrust

(STI) - Get Report

and Chase."

And part of Iseson's reasoning is that many of the favored banks have gotten too expensive already. "Chase at 90? Give me a break," he says.