Big Banks: Summers Bye-Bye Winners (Update 1)

Updated from 4:27 p.m. ET with comment from Ron Beasley, and investment advisor in Houston.

NEW YORK ( TheStreet) -- Morgan Stanley ( MS) was the winner among the largest U.S. banks on Monday, with shares rising over 2% to close at $53.14.

Bank stocks fared even better than the broad market Monday, as investors cheered the withdrawal by former Treasury Secretary Lawrence Summers from consideration to be President Obama's nominee to succeed Ben Bernanke as Federal Reserve chairman.

The KBW Bank Index ( I:BKX) rose 0.8% to close at 64.17, with all 24 index components showing gains. The Dow Jones Industrial Average was up 0.8%, while the S&P 500 ( SPX.X) rose 0.6% and the Nasdaq Composite ended with a slight decline.

Big banks seeing shares rise nearly 2% included Goldman Sachs ( GS), which closed at $67.03, and Wells Fargo ( WFC), which closed at $$42.89.

Shares of JPMorgan Chase were up 1% to close at $53.14, after Reuters and the Wall Street Journal separately reported that the company would agree to pay fines of "at least" $700 million, springing from the compliance and risk-management failures that led to the "London Whale" hedge trading losses that amounted to at least $6.2 billion during 2012. Both reports cited unnamed sources. JPMorgan CFO Marianne Lake at a conference last Monday said the bank's third-quarter legal expenses could exceed $1.5 billion.

The Journal on Friday reported that JPMorgan's second-half expenses from regulatory expenses could rise by an additional $4 billion, including the cost for an additional 5,000 employees "to clean up its risk and compliance problems

The Next Fed Chair

Bernanke's term ends on Jan. 31 of next year, leaving plenty of time for the Senate to confirm a nominee, however, Obama may face difficulty in finding a candidate who can clear the Senate Banking committee, before heading to the Senate floor for a confirmation vote.

Summers has been critical of the Federal Reserve's accommodative monetary policy, while the other highest-profile candidate -- current Federal Reserve System Vice Chair Janet Yellen -- is favored by investors who wish for the central bank to maintain the course it has taken under Bernanke's leadership.

Summers had faced plenty of opposition from Democratic members of the Senate Banking Committee, including Jon Tester (D., Mont.), who had gone on the record saying he was against Summers's potential nomination, and Jeff Merkley (D., Ore.), Sherrod Brown (D.,-Ohio) and Elizabeth Warren (D-Mass.), who were widely expected at least to question the suitability of Summers for the role. Some of the criticism springs from his support of the Commodity Futures Modernization Act of 2000, which prevented direct regulation of derivatives trading between large banks.

Obama may also face a tough time if he nominates Yellen, since Senate Banking Committee member Richard Shelby (R., Ala.) stands out for having voted against Yellen's nomination to be Fed Vice Chair in 2010.

This is a very high-profile week for the Federal Reserve. The Federal Open Market Committee meets Tuesday and Wednesday, after which the committee will release its policy statement and Ben Bernanke will hold a press conference. The FOMC is widely expected to begin tapering the central bank's bond purchases.

The Fed has been making net monthly purchases of $40 billion in long-term mortgage-backed securities and $45 billion in long-term U.S. Treasury bonds since last September, as part of its "QE3" policy to hold-down long-term interest rates. The market has been anticipating an end to the Fed's balance sheet expansion, sending the yield on 10-year Treasury bonds up by over 100 basis points since the end of April.

In light of mixed signals in recent economic reports, the FOMC may decide to wait again before it begins reducing the Fed's bond purchases, but even if the tapering begins, the committee is expected to make no policy change for the federal funds rate, which is the central bank's main policy tool. The Fed has kept the federal funds rate in a range of zero to 0.25%, and the FOMC has repeatedly said this "highly accommodative" policy was likely to remain appropriate at least until the national unemployment rate drops below 6.5%. The August unemployment rate was 7.3%, improving slightly from 7.4% in July.

"We find that there is little compelling evidence that the labor market has improved meaningfully in the past six months, despite the drop in the unemployment rate to 7.3%," KBW analyst Frederick Cannon wrote in a note to clients Sunday. "Therefore, we think the most likely outcome for the Fed decision will be either a very modest tapering of their bond buying (a $5-$10 billion monthly reduction) or a postponement of tapering."

Short-Term Traders Beware

Cannon also believes this may be a good time for investors holding financial stocks to take profits, especially those whose stellar returns this year have been the most correlated with the rise in the yield on 10-year Treasury bonds.

Among the financial stocks with year-to-date gains must correlated with the rising rate for the 10-year, according to Cannon, are TD Ameritrade ( AMTD), U.S. Bancorp ( USB), M&T Bank ( MTB), Prudential Financial ( PRU) and Charles Schwab ( SCHW).

A Longer-Term View

Then again, short-term volatility can be quite a benefit for long-term investors looking to load up on favored names. "it's a silly notion that the considerable long term values in bank shares are somehow irrelevant for the next three months," says Ron Beasley, an investment advisor in Houston, who's portfolio as of June 30 included Wells Fargo and U.S. Bancorp ( USB).

"Over-reactions that are amplified by high-volume trading activity provide opportunities that wouldn't exist in a value-based market," Beasley says, adding that "being a value investor now is actually easier than it used to be, with all this noise surrounding the activity in the markets."

Wells Fargo and U.S. Bancorp have generated by far the strongest and steadiest returns on equity among the largest 10 publicly traded U.S. banks over the past five years. Shares of both companies trade for significant discounts to their valuations before the credit crisis of 2008. Wells Fargo trades for 10.7 times the consensus 2014 earnings estimate of $4.01 a share, among analysts polled by Thomson Reuters. U.S. Bancorp's shares closed at $37.51 Monday and trade for 11.7 times the consensus 2014 EPS estimate of $3.21.

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-- 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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