Don't look now, but market forces seem to be aligning for a very bullish breakout in the banks.
NEW YORK (TheStreet) -- Are the banks ready for a breakout?
The financials are historically at the forefront of a classic bull market, but that wasn't the case at the end of 2011 when this latest run began. Of course, since the calendar turned, beaten-down banks have morphed into favorites, most notably Bank of America(:BAC), whose shares surged 22% last week as the company cleared the hurdle of the Federal Reserve's stress tests.
So far this year, Bank of America's stock has soared 76% to make it the top percentage gainer within the Dow Jones Industrial Average, reversing last year's performance when it was the biggest loser among the blue-chips, down 58%.
Still, 2012's gains have to be considered more of the bargain-bin variety. After all, the 52-week high for Bank of America is $14.21, achieved late last March, and as recently as Dec. 19, the stock closed at $4.99, notching an intraday 52-week low of $4.92 in the process.
The positives for the financials are starting to stack up now though, and that could lead to investors snapping up the stocks for fundamental reasons, and the broad market getting a new leader to follow.
JPMorgan wrote in a research note that it wants to remain overweight cyclical and financial stocks but that financials are the most "non-consensus call."
"Financials are the top 1 or 2 weight in most indices (it is 22% of the Russell 1000 Value) and therefore critical," the firm wrote. "A multiple of factors favor Financials including improving credit conditions (steepening curves), US housing revival, regulatory headwinds flattening, and record low valuations."
JPMorgan goes on to offer 17 top picks from its team of financial industry analysts. They include Bank of America, Wells Fargo(:WFC), Discover Financial Services(:DFS) and Zions Bancorp(:ZION).
The firm also notes that the financials are expected to shoulder a heavy earnings burden for the S&P 500 in 2012, with current analyst estimates calling for the group to deliver "24%-95% of the total EPS growth in 2012 for each of the quarters," showing the industry is expected to transition from a drag on the broad market to a top profit contributor over the course of the year.
And even with this year's run-up (the KBW Bank Index(:BKX.X) has risen 26% in 2012), the group is still cheap on a long-term detrended earnings basis, the firm said. This analysis compares the price-to-earnings ratio for the sector over a 10-year period with that of the S&P 500.
"Near-term earnings for the sector are expected to be depressed due to regulation, a still-recovering housing market, and still-recovering consumer, which have likely held back the performance of this sector," JPMorgan said. "However, based on longer-term earnings, the relative P/10-Yr EPS of Financials is more than 2 standard deviations below its long-term average. While one might argue this low valuation is justified due to the current low ROE return on equity of Financials, this discount is larger than implied by the ROE."
As for the broad market, JPMorgan wasn't quite ready to boost its 2012 target of 1430 for the S&P 500, but it sounds like it could be persuaded.
"Do we believe there is only 30 points of gain between now and YE year-end?," the firm said. "Or given the increasing evidence of a secular bull market coupled with extremely favorable market conditions (positive eco momentum, attractive relative value, investor mis-positioning), is a higher YE target justified? We are inclined to lean to the latter and may adjust targets at the appropriate time."
JPMorgan contends two points favor of stocks' continued rise.
First, "asset allocators" such as pension funds, insurance companies and macro hedge funds still appear to be underweight equities, as evidenced by persistent low volumes.
Second, as bullish as sentiment readings have been of late, the long-term trend is nothing to write home about and the fact remains that a ton of money has been sucked out of stocks by retail investors in the past few years.
"Looking at 100-week sentiment (trend) readings, the level of AAII American Association of Individual Investors net bulls is surprisingly low," the firm said. "Three years into this bull market, this reading of +7 is LOWER than it was at the March 2003 bear market low. And investors have continued to pull money out of equities and pour it into bonds totaling $307b over last 5 years. This of course, has been more than offset by corporate buybacks, which outweigh investor flows 3:1."
As for Monday's scheduled news, it's another light earnings day with Adobe Systems(:ADBE) really the only brand name on the docket.
The Web publishing and graphics design software company is reporting its fiscal first-quarter results after the closing bell, and the average estimate of analysts polled by Thomson Reuters is for a profit of 56 cents a share in the February-ended three-month period, on revenue of $1.05 billion.
The stock is up more than 20% this year, closing Friday at $33.82, just 6% below the 52-week high of $35.99 set back on May 11, 2011. The company announced restructuring plans, including the elimination of 750 jobs, last November as it focuses on its digital media and marketing products.
In its fiscal fourth quarter ended in November, Adobe beat Wall Street's earnings expectations by 11.5%, and forecast non-GAAP earnings of 54 to 59 cents a share for the first quarter on revenue of $1.025 billion to $1.075 billion. The sell side is mildly bearish, though, with 16 of the 28 analysts covering the stock at either hold (12), underperform (2), or sell (2), and the median 12-month price target at $34.00.
ThinkEquity has a hold rating on Adobe, but it lifted its price target to $37 from $29 on Friday ahead of the quarterly report. The firm expects a penny beat from Adobe on the bottom line and said the stock's year-to-date outperformance in comparison with the Nasdaq Composite shows "investors appear more comfortable with the margin impacts associated with Adobe's transition to subscription offerings for its design tools franchise."
A stabilization in advertising fundamentals of late is also a good sign for Adobe, ThinkEquity said.
"We believe the demand backdrop for the company's majority digital media tools and solutions business has improved over the past few months, with improved hiring signs evident in traditional and online U.S. media," the firm wrote.
"We are projecting $760m revenue (flat yr/yr) for Digital Media (Creative Solutions, plus Acrobat," it added. "We are projecting revenue of $264m (+24% yr/yr) for Digital Marketing (Omniture, Day, LiveCycle, Efficient Frontier) enterprise business. Adobe has projected an organic 25% growth target for Digital Marketing this year, and appears intent on continuing an M&A focus there as well, in our view."
Adobe has a streak of eight consecutive upside EPS surprises on the line with this report, with the average beat coming in at 6.5% above consensus. At current levels, the stock has broken above both its 50-day and 200-day moving averages of $32.61 and $28.57, respectively, so there is some anticipation out there for another strong number.
Check out TheStreet's quote page for Adobe Systems for year-to-date share performance, analyst ratings, earnings estimates and much more.
The economic calendar is empty except for the National Association of Home Builders housing market index for March at 10 a.m. EDT. The consensus is for a reading of 31, up slightly from 29 in February.
And finally, Domino's Pizza(:DPZ) should see some buying interest on Monday after the pizza company said it plans to pay a special one-time cash dividend of $3 per share following a successful refinancing of its credit facility that will lower its interest burden. The stock rose more than 4% in after-hours action on Friday.
-- Written by Michael Baron in New York.
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