Buying the Banks

By James J. Cramer

This schizophrenic stock market keeps offering us the chance to buy great companies at good prices, as one sector after another rapidly rotates from favored to hated. Now in the doghouse, for no good reason, are the banks. Two weeks ago, mutual funds and other big investors decided these stocks had become "must owns," given the Federal Reserve's new bias toward easier credit. Shares of the Chases and Citigroups were flying out the door. An index of bank stocks peaked in July at 932, then plummeted to 592 in early October before vaulting back to 789 on Nov. 5, after the Fed's second rate cut.

Then shake-ups at Citigroup--and a growing belief that the economy had got so strong that the Fed would ease no longer--pushed the banks down for 10 days in a row, taking back as much as a third of their recent gains.

To me that smacks of opportunity. If we step away from the transient worry about whether the Fed will cut rates further when it meets this week, we can see that bank stocks are selling for substantially less than almost any other sector of the market. Tech, drugs and even oil shares trade at a much higher valuation, relative to expected earnings. Why? Because many bank loans have gone bad in Asia, Russia and Latin America, not to mention the Long Term Capital hedge fund.

Yet looking forward, the economies of the U.S. and the world have never presented better opportunities for U.S. banks. First, our banks, once hostage to the cycles of lending and growth, increasingly get their earnings from steady fees: for ATM use, bounced checks, late payments and so on.

Second, banks that have merged and merged again in the past few years are finally reaping the benefits of operating efficiencies, closed duplicate branches and massive investments in technology. By now, pretty much every big bank that can be bought has been bought. That means no more new issuance of stock and, instead, a consistent plowing back of earnings to investors, mainly through aggressive stock buybacks. In the past few weeks Citigroup and First Union have announced buybacks for $2 billion each. And Chase is buying back even more.

Further growth may spring from the hobbling of foreign competitors. For 15 years Japanese banks have battled for market share in U.S. real estate and corporate lending. At times they have undercut U.S. banks to the point where the business became unprofitable. But the Japanese banks hold so many bad loans in Asia that they are scaling back dramatically in the U.S. European banks aren't faring much better. Both trends should boost profits for U.S. lenders.

That's why I am buying the major U.S. banks, whether or not the Fed eases this week. To be sure, if the Fed keeps rates steady, these stocks will sell off on Tuesday and Wednesday. Nevertheless, I am betting they will come roaring back soon. With or without a Fed rate cut, I am buying into a group that is nowhere near its highs at a time when most stocks have recovered nicely. In this market, nothing stays out of favor for long. When the world's growth recovers, these stocks will surge back to much higher valuations. I'm betting we will look back and marvel that we got this second chance to buy high-quality financials at a discount.

Cramer runs a hedge fund and writes daily for thestreet.com He holds an investment in Chase. Nothing in this column should be construed as advice to buy or sell stock. See time.com/personal for more on banks.