Thursday, July 27, 2006

Are Banking Stocks Safe?

With money moving into more defensive sectors, the banking stocks are in the spotlight. Banks are typically considered one of the defensive sectors because they are mostly high dividend yielding stocks. Some people call high dividend yielding stocks value stocks, some call them defensive stocks and some just call them great investments. For the past forty years quality value stocks, of which banks are a subset, have been the best performers for buy and hold investors.

But has history been kind to banking stocks in bear markets? Well, not really and sometimes they've actually punished banking related stocks. We've seen our fair share of financial failures in the US over the last one hundred years as well. In 2000 to 2003 many of the banking stocks were down over 50%. Do you really want to hold JP Morgan Chase from $55 to $14 as happened in the last bear plunge? I don't. Now, six years later JPM is close to its 2000 peak but how does one know the next drop won't take six more years to return to 2006 levels? Or, maybe ten years. Or maybe JPM may never return to current levels if it heads south. The point is that holding through a serious down draft presents many risks and JPM's 3% dividend yield, as and example, is a paltry sum for me to take that risk.

If housing does have a hard landing and consumers do quit spending and bankruptcies increase and on and on, banking stocks could be at significant risk for a substantial down draft. Their lending practices and risk management has been pretty poor from what I've seen. Some people argue we don't have a housing bubble but that we have a high risk lending bubble. Only time will tell but if banks have peaked and do fall significantly, the party has yet to start.

A little more pattern work. George Lindsay's work was first shown using the Morgan Stanley Cyclical Index a few weeks ago. Let's look at the Banking Index using the same "Three Peaks and a Domed House" pattern. For background on Lindsay's work, look back at my post dated July 18th. As usual, you may click on the chart for a larger view. Chart courtesy of the wonderful prophet.net.

posted by TimingLogic at 1:23 PM