Daily Gains Letter

How the 2008 Stock Market Crash Made These American Banks Safest Investments Now

By for Daily Gains Letter |

Bank StocksWhen Lehman Brothers Holdings Inc. crashed after the impact of the sub-prime financial crisis in 2008, the financial sector was turned upside down. Regulators made a bold and smart decision to clean up the banking sector and its somewhat secretive high-risk activities.

Fast-forward nearly seven years, and the banking sector is clearly stronger and more trustworthy than it has ever been. Investors can thank the annual Federal Reserve bank stress test for this.

Fed’s Stress Test Making Banks the Safest Investment for Long-Term Investors?

The Fed’s financial crisis stress test aims to analyze the stability of the country’s largest banks with assets of more than $50.0 billion. It includes both a round one quantitative test and a round two qualitative portion.

After the rigorous testing based on the assumptions of a severe financial crisis, all but three banks passed. While all of them made it through the first round, only the U.S. units of Santander and Deutsche failed on a qualitative basis. The Bank of America Corporation (NYSE/BAC) was approved based on the acceptance of a new capital strategy by the end of September.

The financial crisis stress test is critical, as it gives investors and consumers confidence in the country’s banking system and pushes the banks to put measures in place to help avoid the mess we witnessed in 2008. The promise of the financial crisis testing is to put the various banks under the worst economic situations and see how they would fare. The assumptions under a financial crisis include severe recessions, high unemployment above 11%, plummeting home prices, and a crash in the stock market by 50%.

So while I doubt we will see these types of financial crisis scenarios play out at this point, the fact that the banks could theoretically survive them based on this test gives confidence to the financial system.

Bank Stocks Making Strong Gains Since 2008 Collapse

We have seen strong gains by banking stocks since the recession in 2008, which also provided an exceptional opportunity for investors to buy the sector at extremely cheap prices. (I recall Citigroup Inc. [NYSE/C] trading at a dollar and the Bank of America at $6.00!)

Back then, bank stocks were a great contrarian opportunity, which will likely not happen again, at least not to the same degree. Yet now we can expect bank stocks to provide decent dividends and capital appreciation opportunities for investors who depend on income.

The chart of the Philadelphia Bank Index shows the upward move of bank stocks from the 2009 and 2011 bottoms to the present. Bank stocks retrenched from March to May of 2012 on the European bank concerns and Moody’s Investors Services’ downgrade of the sector. However, the group has since staged a rally back to above the 50- and 200-day moving averages.

Bank Index Chart

Chart courtesy of www.StockCharts.com

While the sector as a whole looks good, some of the top players to watch may include Citigroup, Morgan Stanley (NYSE/MS), The Goldman Sachs Group, Inc. (NYSE/GS), JPMorgan Chase & Co. (NYSE/JPM), and HSBC Holdings plc (NYSE/HBC). A banking exchange-traded fund (ETF), such as the SPDR S&P Bank ETF (NYSEArca/KBE), could provide another reasonable approach to the sector.

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