Discover Leads as 'Fed Mania' Ramps Up

NEW YORK (TheStreet) -- Discover Financial Services (DFS) led bank stocks higher on Monday, with shares rising 1.3% to $53.42, as investors looked ahead to next week's policy meeting of the Federal Open Market Committee.

Monday's eonomic calendar was light, after last week was dominated by positive reports, including the improvement of the U.S. unemployment rate to 7.0% in November from 7.3% in October, the Labor Department's report that the U.S. economy had added 203,000 nonfarm jobs during November, and the upward revision of the previous two months' job-growth data.  Also last week, the Bureau of Economic Statistics on Thursday made a major upward revision of its estimate for third-quarter U.S. gross domestic product growth to an annual rate of 3.6% from the previous estimate of 2.8%.

All that good news for the economy means "the market is now obsessed with assessing the odds of a December 18 action, and this week's data and events will be scoured for clues," according to BMO Capital Markets economist Douglas Porter. 

Porter was referring to the next meeting of the FOMC on Dec 17-18, after which the committee will put out its usual statement on Federal Reserve policy.  The action many investors expect the central bank to take is a tapering of "QE3" purchases of long-term U.S. Treasury and agency mortgage-backed securities.  These purchases have been running at net monthly pace of $85 billion since September 2012.  It's difficult to say whether or not a slight curtailment of the Fed's bond purchases is already "priced in" to bond prices, but stock investors may also be jittery, in the midst of a two-year bull run.   The market yield on 10-year U.S. Treasury bonds was 2.86%, having risen quite a bit since it was 1.70% at the end of April, before the endless talk of "Fed tapering" began.

In a note to clients Monday, Porter wrote that "on Thursday, retail sales should rise a respectable 0.6% in November, driven mostly by vehicle purchases."

"November chain-store sales were lackluster, and dollar totals were restrained by aggressive Thanksgiving-related discounting along with some slippage into December owing to the holiday's late date as well as to on-line vendors. We look for retail sales to rise 0.3% both ex-autos and ex-autos/gas. Given the aggressive price discounting, real retail sales should record a respectable increase as well," he added.

The KBW Bank Index I:BKX ws up 0.3% to 67.60, with all but eight index components ending with gains.  The index has returned 32% this year, following a 30% gain during 2012. 

Bank stocks have been hot, with a significant rise in industry stock valuations relative to earnings estimates, showing plenty of faith in the multiyear recovery, since analysts' earnings estimates on average have only risen 3% over the past 12 months, according to Sterne Agee analyst Brett Rabatin.  That means picking winners could be tricky over the next year.  Sterne Agee on Sunday listed M&T Bank (MTB) of Buffalo, N.Y., and five small-cap and mid-cap names, as the only ones with "buy" ratings from the firm, with forward P/E multiples below their historical norms and core earnings performance above 10-year averages. 

Shares of M&T rose 0.5% to close at $114.89.

It's been quite a year for the largest U.S. banks and their investors.  The regulators and the Justice Department have been seen one victory after another, culminating with JPMorgan Chase's whopper of a $13 billion settlement last month.

Next Up, Volcker

The Federal Reserve, U.S. Treasury and other regulators are set to "vote" on the finalized set of regulations to implement the Volcker Rule, which is part of the Dodd-Frank banking reform legislation.  The regulators first proposed the rules back in October 2010, and after more than two years struggling over definitions of terms and "exceptions" to the ban on short-term proprietary trading by the nation's largest banks, nobody expects any "no" votes over Volcker.

There's quite a bit at stake with Vocker, and it's possible that the final rules will be the catalyst for the banks giving Washington just what it wants, which is a series of spinoffs of investment banking operations from traditional commercial banking.  For more on what the ban on proprietary trading might mean for the big banks and which companies might see their market shares improve, please see Volcker Rule Puts Non-Bank Financials Into Play.

Discover

Shares of Discover have returned 40% this year.  The shares trade for 10.5 times the consensus 2014 EPS estimate of $5.08, among analysts polled by Thomson Reuters, and for 9.9 times the consensus 2015 EPS estimate of $5.41.  Those are pretty low forward price-to-earnings ratios in this market, considering that Discover's return on average tangible common equity for the first three quarters of 2013 was 26.04%, according to Thomson Reuters Bank Insight.

For more on credit card stocks, please see Capital One, Discover Are Bargains as Industry Resumes Growth.

DFS ChartDFS data by YCharts


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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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