Why Big Banks Can Give Your Portfolio a Lift

Hunter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Stocks soared to their third consecutive week of strong gains, riding optimism over the continuation of quantitative easing programs to record highs. The Fed’s statement that tapering of QE could begin later this year threw the markets into turmoil. Shortly thereafter, though, Bernanke’s assurance that QE would not be ended too hastily sparked a resurgence in the markets. Since then, remarkable gains have been recorded, especially in the banking sector.

Who are the movers?

Bank of America (NYSE: BAC) closed up 4.3% from the previous week, and has shown consistent gains since the June 19 Federal Open Market Committee meeting. News on the Bank of America front has been rather quiet, but right now it’s safe to say that no news is good news. There have been no announcements of fines, lawsuits, or regulatory actions.

JPMorgan Chase (NYSE: JPM) beat estimates with the release of its Q2 FY13 earnings statement. It posted profits of $1.60 per share, over predictions of just $1.44. Not only that, but Q2 earnings were up 31% from FY12. Furthermore, revenue beat predictions by about $1.1 billion, ringing in at $26 billion.

Wells Fargo (NYSE: WFC) also released its Q2 earnings statement, which showed improvements. The bank's EPS beat estimates by $0.05 ($0.98 vs $0.93). Profits increased by 19% over the previous year. However, revenue stayed essentially flat. It remains the largest mortgage originator, accounting for 22% of new mortgages in America

Where will they go from here?

JPMorgan Chase has exhibited strength in its investment sector, which bodes well for the bank. Also, the improvement in the economy has allowed it to reduce its reserves for loan losses. Together, these point to the possibility of a strong future profit-wise for the company.

However, CEO Jaime Dimon warns of a “dramatic reduction in future mortgage profits from higher interest rates.” As the second-largest lender in the U.S., this is a huge risk factor. However, the shock from rate increases should be mostly reflected in the third quarter upon all big banks. Long term, it shouldn’t hurt JPMorgan, since its operations are not as centralized around mortgages as Wells Fargo.

Bank of America’s future is largely dependent upon the results of the impending release of its Q2 earnings statement. If JPMorgan Chase and Wells Fargo are any indication, the release should look good. An increase in profits is to be expected, and that should continue into the future.

Remember, though, that Bank of America is still involved in a lawsuit with AIG over bad mortgages. That could become an issue in the future, but for now investors should see no evil in that arena. Bank of America must be wary of the reduction in mortgage profits as will, yet as far as risk factors go it’s not lethal. It will take the hit and bounce back without too much trouble. It will not have a substantive effect on the bank's long-term prospects.

Wells Fargo will take the biggest hit from rising interest rates. Its mortgage-related income declined year-over-year by 3%, and it has yet to face the worst of the storm. Improved credit quality salvaged a 19% increase in profits, but investors would do well to watch the progression of mortgage-related income. If it drops drastically, buyers beware. However, its forward P/E outpaces the industry average, so when you couple that with the increases in credit quality you’ve got a recipe for success.

Foolish bottom line

There’s a lot to be wary of when it comes to investing in banks. Their reactions to the Fed’s actions tend to be fairly strong, so if Bernanke chooses to taper or end the $85 billion bond-buying program this year, these stocks could face some significant struggles.

Also, it’s very important to be aware of legislative actions—Senators Elizabeth Warren and John McCain have proposed what amounts to a re-institution of the Glass-Steagall. A hard line between trading and lending would drastically change the landscape of banking.

Barring the end of QE and the implementation of “Glass-Steagall 2,” all three stocks discussed have fairly strong prospects. Consumer spending is up, and lending should rise with it. Credit quality will increase as well, which is highly profitable for the banks. There are a few caveats regarding rising interest rates, but for the most part the big banks are on the rise and should continue their runs.

Hunter Hillman has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase & Co., and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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