Bank Stocks Cool Off for the Summer

NEW YORK ( TheStreet) -- After a roaring start to the year, bank stocks are losing steam, underperforming the broader markets in the second quarter so far, despite a mostly positive earnings season.

The KBW Bank Index has slipped 2.9% since April 13, which marked the beginning of the bank earnings season, while the S&P 500 has lost about 1.5%.

Bank of America ( BAC), which led the market rally in the first quarter has shed 17% in the past month alone. Citigroup ( C), which also benefited from the "risk-on" rally in the early part of the year has shed about 10%.

Meanwhile, safer bets such as JPMorgan Chase ( JPM) and Wells Fargo ( WFC) have managed to contain their weakness relatively better than their large-cap peers, losing only 4% and 1% respectively.

This is starting to look eerily like 2011, when bank stocks performed well in the early part of the year, only to become the worst performers of the year as European debt crisis intensified and macro-economic data took a turn for the worse.

Should investors cash their chips and run?

At least some of the weakness in bank stocks can be explained by the recent string of lackluster macro-economic data and resurgent fears about the European debt crisis.

Bank stocks are highly correlated to economic news, so the volatility associated with macro headlines is something most investors learn to live with.

For the big money center and universal banks such as JPMorgan Chase and Bank of America, however, the macro-economic uncertainty also takes a toll on trading revenues. That in turn could affect earnings estimates.

Analysts have raised estimates for the biggest banks since they reported first quarter results on the back of better-than-expected improvement in trading revenues. But already, the outlook for capital markets is starting to dim.

Investors are starting to turn skittish again, based on the early performance of risk assets in the second quarter. " Given the slow start to 2Q12, once again driven by macro headlines, investors seem to have decided to reduce their exposure to capital markets stocks until evidence of better activity surfaces. Unfortunately, we think activity levels could remain muted in the near term given the lack of investor and CEO confidence right now," Nomura analyst Glenn Schorr noted in a report titled "Dejas 2Q All Over Again?"

Most banks that have reported so far have beat expectations, but the bar was somewhat low to begin with. While banks surprised with better-than-expected mortgage banking income and net interest margins, loan growth trends were mixed, with most reporting some slowdown in growth.

Also bank results continue to come with their usual share of noise in the form of DVA gains and losses- accounting gains or losses from the changes in the fair value of a bank's debt and loan loss reserve releases, which makes it harder for investors to determine if banks have really managed a "clean" quality beat.

Still, analysts remain bullish on the sector. "Even after the YTD rally, the brokers and universal banks continue to trade at reasonable earnings and low tangible book multiples," Schorr wrote.

Rochdale Securities analyst Dick Bove, who has also long been bullish on the sector, expects some weakness in bank stocks in the next few months, but not for fundamental reasons.

Bove expects it to be a "long, hot summer" in that "the fundamentals of the banks would be quite good but the market would not be".

"Investors are likely to note continuous increases in bank earnings through the summer but no positive movement in bank stocks," he wrote. "It is my belief that the bank stocks I recommend will have a very good year but not a very good summer."

The analyst believes bank stocks could pick up post fall and recommends investors continue to buy bank stocks in small lots but not to expect strong upside over the next few months.

--Written by Shanthi Bharatwaj in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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