Where to Hide When Bank Stocks Bomb

NEW YORK ( TheStreet) -- A clear case can be made that the fourth quarter looks pretty weak for bank stocks, but where should investors turn?

Uncertainty over the elections, the implementation of health insurance requirements for business, and the "fiscal cliff," are all weighing on bank stocks, as commercial loan growth -- a main story for large U.S. banks over the past year -- looks to be drying up until the first quarter of next year, as businesses take a wait-and-see approach to expansion plans.

The fiscal cliff is the possible year-end expiration of the income tax cuts -- including the 15% maximum tax rate on qualified dividends -- signed into law by President George W. Bush and extended by President Obama in 2010, as part of the compromise with Congress to raise federal debt ceiling limit. The 2010 budget deal also requires major federal budget cuts beginning in 2013, unless Congress acts.

With the threat of the U.S. economy slipping back into recession from the combination of tax increases and federal spending cuts, most analysts expect a congressional compromise to extend the tax cuts again and avoid the spending increases, but not until very late in the fourth quarter.

Professional investors are taking different approaches in handling a possible short-term meltdown for financial names. Some say that the long-term story of economic recovery is intact, and that banks should benefit over the next couple of years from the housing recovery, as well as a "coordinated global period of economic recovery," according to Fifth Third Bank senior vice president and chief investment strategist Jeff Korzenik, who favors "a balanced approach," to investment allocation and says "financials, energy and healthcare are always affected by elections."

"We take a little bit different view," Korzenik says, "and think that by the fourth quarter of next year, the economy will be almost like the old days."

"We see the green shoots in China," he says, "and the U.S. housing recovery will be in full bloom" by the end of 2013.

Among the banks, Korzenik still likes JPMorgan Chase ( JPM), and American International Group ( AIG), "where you have an interesting buyback story, so we think there are places to be, in those sectors, despite all the short term problems."

JPMorgan Chase ( JPM) is showing itself to be an earnings powerhouse, despite the company's second-quarter hiccup, when it booked $4.4 billion in trading losses from the hedging activity of its Chief Investment Office. The company still earned $5 billion, or $1.21 a share, during the second quarter, and then reported third-quarter earnings of $5.7 billion, or $1.40 a share, for a solid return assets of 1.74%, and a return on tangible common equity of 16%.

Investors will be looking for a major return of capital from JPMorgan after the next round of Federal Reserve stress tests are completed late in the first quarter of 2013. The company suspended its $15 stock repurchase program in May, after CEO James Dimon first announced the CIO losses. JPMorgan Investors may also be treated to another dividend increase after the stress tests. The shares were up 27% year-to-date through Friday's close at $41.16. Based on the current quarterly payout of 30 cents, the shares have a dividend yield of 2.92%.

JPMorgan's shares trade for 1.2 times tangible book value, according to Thomson Reuters Bank Insight, and for eight times the consensus 2012 earnings estimate of $5.31, among analysts polled by Thomson Reuters, which are rather low valuations for this type of earnings performer.

AIG may be taking some serious lumps from Hurricane Sandy, as the company has a significant property & casualty market share in the Northeast. Unlike most of its major P&C competitors in the region, AIG reported an underwriting loss of $397 million during the first half of 2012, although the loss narrowed from $1.962 billion, during the first half of 2011.

AIG has made a ton of progress in repaying the federal government after the company was bailed out in 2008 and 2009. The company's shares were up 50% year-to-date, through Friday's close at $34.72, and traded for 10 times the consensus 2013 EPS estimate of $3.50.

For defensive-minded investors, Korzenik likes real estate investment trusts that focus on multifamily buildings. "We usually approach REITs through ETS," he says," adding that "what we saw in the summer rally was that a lot of money moved into more aggressive names, and some of the steady-as-you-go names, including the REITs, just fell by the wayside. Now we think there's a period where there's renewed interest."

Two of Korzenik's favorite REIT plays are American Campus Communities ( ACC) and Essex Property ( ESS).

Korzenik also likes "the low end of consumer discretionary. "We like Yum! Brands ( YUM) a lot, for their domestic and international exposure," he says, and also Lorillard ( LO), which also features an attractive dividend yield of 5.41%, based on a quarterly payout of $1.55 a share, and Friday's closing price of $114.57.

Shares of Yum! Brands returned 21% year-to-date through Friday's close at $69.90. Based on a quarterly payout of 33.5 cents, the shares have a dividend yield of 1.92%. The company's shares trade for 19 times the consensus 2013 EPS estimate of $3.74.

YUM operates KFC, Pizza Hut and Taco Bell. For its fiscal third-quarter ended Sept. 8, the company reported net income of $471 million, or a dollar a share, increasing from $383 million, or 80 cents a share, from the fiscal third quarter of 2011. Revenue was up 9% year-over-year, to $3.569 billion, in the fiscal third quarter.

YUM said that for its China division, same-store sales grew 6% year-over-year, while operating profit -- excluding the effect of foreign exchange -- rose 24% to $374 million.

Lorillard's stock returned 4% year-to-date, through Friday's close at $114.57. The stock was down 23% of a year-to-date intraday high of $141.07 on July 16. The cigarette manufacturer -- which includes Newport, Kent and True among its brands -- last week reported third-quarter earnings of $283 million, or $2.16 a share, increasing from $267 million, or $1.94 a share, during the third quarter of 2011. Net sales grew 2% year-over-year, to $1.661 billion in the third quarter.

Lorillard CEO Murray Kessler said the company "continued to execute against its strategic plan as it began to invest in advertising, distribution and merchandising on blu eCigs, the leading e-cigarette brand acquired earlier this year," and that "the Company expects to continue to deliver a double digit total shareholder return, as measured by EPS and the dividend yield, while it makes these strategic investments."

Lorillard's shares trade for 13 times the consensus 2013 EPS estimate of $9.10.

Grimes & Co. securities analyst Benjamin Wallace says that he "would rather be focused on asset managers than bank that are facing these risks," and that "our process is looking bottom up art business with high returns on capital. Asset managers pop up, where there banks don't."

"Within the financial space, we own BlackRock ( BLK)," Wallace says.

BlackRock reported third-quarter earnings of $642 million, or $3.47 a share, increasing from $554 million, or $3.08 a share in the second quarter, and $595 million, or $3.23 a share, in the third quarter of 2011. Revenue grew 4% sequential and year-over-year, to $2.320 billion in the third quarter. Black Rock's third-quarter adjusted operating margin was 40.7%. The company bought back $1.3 billion in common shares during the first three quarters of 2012.

BlackRock's shares closed at $186.99 Friday, returning 8% year-to-date. Based on a quarterly payout of $1.50, the shares have a dividend yield of 3.21%. The shares trade for 13 times the consensus 2013 EPS estimate of $14.89.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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