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Bank Stocks Now Are Like Tech Stocks in 2003

Anyone who has been watching the major trends in the financial sector has first been struck by the gut-wrenching volatility. Bank of America (NYSE:BAC) lost 58% last year, and is up 67% so far in 2012. JPMorgan Chase (NYSE:JPM) has a similar story, with a 52-week range of $28.28 to $46.49.

This is a risky sector, make no bones about it. But according to investment shop KKR (NYSE:KKR), financial services could be one of the most profitable places to put your money in the long-term.

According to Henry McVey, KKR’s Head of Global Macro & Asset Allocation, this is because of secular trends and not cyclical ones lifting the financial services sector.

Here’s what he wrote Monday in a new report on the financial services sector:

“Heightened regulation, de-leveraging, and low rates are all challenging traditional financial intermediaries to ponder what will be the key drivers of growth and returns in this new and unfamiliar environment. Our base view is that these changes are secular, not cyclical, and as such, we think now is the time for all investors associated with the industry to consider the role financial intermediaries will play in the capital formation and distribution process in the future.”

What I really find fascinating about this report is its connection to the flop of the tech sector after the dot-com crash, and how it might portend a subsequent recovery for financial services and bank stocks as they adapt to the “new normal” of risk-averse investors and a changing competitive landscape.

If bank stocks now are like tech stocks were circa 2003 or so … well, that would be one hell of a run in the next 10 years!

Here are some highlights of why you should buy financials, according to KKR:

  • Lower volatility ahead: “Today the beta in the financial services industry in the United States is 1.4, down from a peak of 1.7 in October 2010,” McVey writes. And going forward “our research leads us to think it could drop to 1.0 or so over the next 2-3 years.” Check out the accompanying chart to show how the industry might settle down, much like tech did after the dot-com bubble burst and companies got into a more “boring” equilibrium.

  • Emerging Markets Beyond the BRICs: “Within the emerging markets (EM), we still expect outsized growth,” the KKR report reads, though it acknowledges the big guys like China and Brazil see headwinds.
  • Recovery Aiding Business Cycle: “Our research shows that U.S. housing is bottoming, autos sales are increasing, and U.S. manufacturers are now more competitive,” McVey writes. “As these industries — as well as new ones that spring up — look for solutions to their financing needs, there will be tremendous opportunity for financial services companies that can partner with these companies to grow their businesses within the United States.”

There are risks, however:

  • Still Contracting in the Near Future: “Our research shows the sector’s market cap contracting by another 250 to 300bp from the current 15% of the overall U.S. public equity market over the next 3-5 years,” McVey wrote.
  • Regulatory Picture Remains Uncertain: In many respects, bank stocks have been damaged due to the prospect of a harsher regulatory environment. The good news is that “Heightened regulation, de-leveraging, and low rates are all challenging traditional financial intermediaries to ponder what will be the key drivers of growth and returns in this new and unfamiliar environment,” as the KKR report says … meaning banks are forming their game plans. Unfortunately, they won’t know the final rules for some time yet — especially with an election in the U.S. this November with so much at stake.
  • Euro Crisis Saps Lending, Particularly Abroad: Fallout from EU debt woes “will dampen cross-border lending in Europe and … lending to Asia will also be curtailed in certain instances,” the KKR report reads. It references a Morgan Stanley (NYSE:MS) report that shows a decline from big financing deals from Europe to Asia of staggering proportions — from a 43% share of deals in 2010 to just 3% today. Ouch.

All in all, the report is an interesting read, though a thick one with lots of diversions into the eurozone crisis and the prospects of inflation stoked by central banking. But it’s comprehensive and valuable, so take a look.

The full KKR report is available here on its Global Macro Trends portal.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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