Bank Stocks Lead Bulls: Financial Winners

Updated from 4:22 p.m. ET with comments from Guggenheim analyst Marty Mosby.

NEW YORK ( TheStreet) -- Bank of New York Mellon ( BK) was the winner among the largest financial names on Tuesday, with shares rising 4% to close at $32.26.

The broad indices all ended with 1% gains, as the Dow Jones Industrial Average and S&P 500 ( SPX.X) pass intraday record highs. Financial stocks led the way, with the KBW Bank Index ( I:BKX) rising 2% to close at 59.85, with all 24 index components ending the session with gains.

Big banks seeing shares rise 3% on Tuesday included Goldman Sachs ( GS), which closed at $154.52; Bank of America ( BAC), closing at $13.34; State Street ( STT), at $63.59; Northern Trust ( NTRS), at $56.67; and Huntington Bancshares ( HBAN), which closed at $7.69.

As the U.S. economic recovery proceeds, investors have obviously been showing increasing willingness to take on risk, sending the Dow Jones Industrial Average and S&P 500 both up 16% this year, the KBW Bank Index has risen 17%.

A major factor in the recovery has been massive stimulus from the Federal Reserve, which has kept its short-term federal funds rate in a target range of zero to 0.25% since the end of 2008. Since September, the Fed has keep up its monthly purchases of $85 billion in long-term securities, in an effort to hold long-term rates down.

Of course, the Fed cannot continue increasing the U.S. money supply at this rate forever, and the Federal Open Market Committee (FOMC) said after its last meeting on May 1 that it was "prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes." That was a change in the FOMC's language from previous statements, when the committee merely said it would "take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives."

Speaking Tuesday at a conference in Stockholm, Federal Reserve Bank of Philadelphia president Charles Plosser said that the " changes in the size and composition of the Federal Reserve's balance sheet pose challenges for the Fed's eventual exit from this period of extraordinary accommodation and for the normalization of monetary policy."

Plosser minced no words in saying "I believe that labor market conditions warrant scaling back the pace of purchases as soon as our next meeting." The next FOMC meeting will be on June 18 and June 19. Plosser also said he expected the Fed to stop its net purchases of long-term securities by the end of 2013.

He reinforced his point by saying "were the FOMC to refrain from reducing the pace of its purchases in the face of this evidence of improving labor market conditions, it would undermine the credibility of the Committee's statement that the pace of purchases will respond to economic conditions."

Stock investors have been having their cake and eating it too, with economic reports showing a U.S. recovery for quite some time, but with unemployment levels remaining over 7%, thus leading the Fed to continue its balance sheet expansion. This has made it more and more difficult for bond investors to find decent yielding paper, thus making stocks more attractive.

With the broad market -- and bank stocks -- seeming to go up nearly every day, it's only a matter of time before the market takes a breather. It will be fascinating to see how the Fed plays its eventual easing of securities purchases and the eventual increase for the federal funds rate, because the central bank's extreme stimulus measures, and the duration of the measures, are unprecedented.

Guggenheim analyst Marty Mosby says that one of the reasons investors are warming to bank stocks is that the major players showed such strong efficiency improvements during the first quarter.

"We thought large banks' earnings would grow by 15% this year, while the market expectation was 5%," Mosby says, adding that "expense savings represented 80% of the variance" of his forecasts to the consensus.

"During the first quarter, we got two thirds of the efficiency improvement we expected for the entire year," Mosby says.

When discussing how the Federal Reserve will curtail its long-term economic stimulus, Mosby says "they won't raise the federal funds rate until well after they have stopped expanding the balance sheet." The analyst expects the Fed to end its net long-term securities purchases by the middle of 2014. "Once that is in place and they are comfortable the economy can absorb that shock, then they will judiciously raise short-term interest rates."

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

>Contact by Email.

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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