Banks and Builders: Can 2012’s Winners Keep Rallying?

Banks and Builders: Can 2012’s Winners Keep Rallying?

REUTERS/Rebecca Cook

To have really outperformed the market in 2012, you had to believe firmly in two related concepts at the beginning of the year. First, you needed to have conviction that the housing market had hit rock bottom, as the data was suggesting at the time. Second, you had to believe that the financial stocks that had contributed to or caused (depending on your personal opinion) the real estate market’s plunge and the financial crisis also were poised for a rebound.

True, broad stock market returns in 2012 weren’t all that shabby, especially given the degree of uncertainty surrounding Europe’s crisis, the U.S. fiscal cliff and slowing growth in China. The Standard & Poor’s 500-stock index wrapped up 2012 with a total return of 16 percent and nine of its ten sub-groups also ended the year in positive territory (the outlier being utilities, which fell an aggregate 4.2 percent).

But as always, the devil was in the details. For instance, while the financial stocks in the S&P 500 returned an impressive 24.53 percent for the year, you really wanted to kick off 2012 owning the most despised members of that group if you hoped to make a killing.

Bank of America (NYSE: BAC), for instance, saw its stock price soar nearly 107 percent in 2012, while Citigroup (NYSE: C) jumped 44.3 percent. Meanwhile, the banks that rode out the storm without ever really approaching collapse lagged those two: JPMorgan Chase (NYSE: JPM) gained 27.7 percent, while Wells Fargo climbed 22.9 percent. Bank of America in particular has attracted a lot more fans, ranging from Evercore Partners analysts to legendary mutual fund manager Bill Miller of Legg Mason, and it resumed its outperformance on the first day of trading in 2013, jumping 3.6 percent as the S&P gained 2.5 percent.

Then there were the housing stocks, which were even more generous to their owners throughout much of 2012. PulteGroup (NYSE: PHM) soared 186 percent, Lennar’s (NYSE: LEN) share price came within a whisker of doubling, and KB Home (NYSE: KBH) rocketed 135.5 percent higher.

RELATED: 2012 Stock Market Winner and Losers

Can any lessons be drawn from what happened in 2012? And can these groups repeat their dramatic gains?

Let’s take the second question first. The answer is, probably not. Or at least, while they may continue to outperform, odds are that their gains will be more modest in both absolute and relative terms.

What both groups benefitted from during 2012 was a complete reversal in sentiment about both their industry and their specific businesses – a shift from conviction that these were the stock market equivalents of toxic waste to the certainty that these companies not only would manage to survive but to post significant gains in earnings. To at least some extent, those improvements are now priced into the stocks, as seen in Bank of America’s price/earnings ratio, which (on a trailing 12-month basis), has soared 250 percent in the last 12 months, while that of Citigroup has more than doubled. The P/E expansion for PulteGroup and Lennar has been much less dramatic but still notable, climbing more than 20 percent.

Still, there is at least one indicator that suggests – in a contrarian kind of way – that financial stocks, at least, may extend their outperformance. A study of 2012 picks by Wall Street strategists, monitored by Birinyi Associates, showed that the financials came second to last among their recommendations. This year, only three of the nine Wall Street strategists Birinyi is watching have suggested that investors overweight the group. If these strategists remain poor prognosticators, the odds favor some further gains.

There is one big argument in favor of an extended rally, both for financial stocks (especially those that are still coming back from the edge of the precipice) and for stocks as a whole. That is the relatively muted level of investor enthusiasm, and the willingness of the market to be spooked by headlines. There’s no irrational exuberance to be found here (even in the midst of a relief rally in the wake of a temporary deal avoiding the ‘fiscal cliff’), but only the proverbial wall of worry.

The gains in the homebuilding stocks and in the banking sector’s big winners serve to remind us of an even more important point: Regardless of what the broad market may do – or even how individual sectors perform – above-average returns come down to which stocks you own and which you avoid. Investors in actively managed mutual funds whose portfolio managers believed that Bank of America was undervalued a year ago are almost certainly celebrating more than those whose managers’ exposure to the financial sector was confined to safer bets like JPMorgan and Wells Fargo (NYSE: WFC).

The odds heavily favor the gains from a handful of individual companies in 2013 dwarfing those of the market as a whole. That doesn’t mean that you should rush out and buy stocks that the market today looks on with loathing – certainly, not all unloved stocks enjoyed the gains that Bank of America or PulteGroup did in 2012, and steering clear of big losers is often the key to posting long-term gains.

But as we make our New Year’s resolutions, this is the time to remind yourself to keep an open mind, and to look for signs that the market’s bearish consensus on a particular company or industry may no longer be supported by the evidence. It might take time for the market to believe that a turnaround story is real, but it is precisely during that time that an investor who is able psychologically and financially to put some money at risk will be able to capture the biggest gains.