The broad market in virtually every equity sector in the US appears to be recovering, however, there is one exception – banks. Yes while large cap banks certainly appear to be beating a very bullish path, their smaller cap “rivals” remain bogged down in a trench warfare style battle with the bears. The Russell 2000 Bank index is still negative for this year (-30%), which is a far cry from the performance of the broad Russell 2000 (up 25% YTD).
We have made no secret of our bullish outlook for equities ever since November last year. One by one each sector has broken out of significant bottom formations but the small cap banking sector refuses to do so, perhaps for very good reasons. If there is one concern we have right now about the health of the equity market rally it is the lack of participation of the very sector that was caught in the eye of the financial storm – i.e. banks. Valuations are certainly not demanding with the price/book ratio of small cap banks being 0.98. Yes we are well aware that this is a rather elementary means by which to value banking stocks but taken as a whole, this valuation implies that small cap banks will never provide a return in excess of their cost of capital! A realistic order over the coming months perhaps but over the long term that appears to be a very pessimistic valuation!
We cannot help but get excited about a sector that everyone else regards as toxic waste. But we will have to sit on our trigger happy hands until we see evidence of a bullish breakout. That level to watch in the index above is the 50 level. On breach of that we will quietly assume a meaningful position in the KBW Regional Bank Index (KRE)….the valuation there is even cheaper – with a p/book ratio of just 0.89%!
