Why the Banks Are Surging

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Today, Bank of America (NYS: BAC) and JPMorgan Chase (NYS: JPM) led the Dow Jones Industrials (INDEX: ^DJI) up 0.44%, to 13,252.76, and the broader banking sector helped lead the S&P 500 up 0.60% to close above 1,400 for the first time since 2008. 

The Federal Reserve's announcement of banking "stress test" results on Tuesday has led to surging bank share prices. The KBW Bank Index is up 8.8% since Monday's close, including a 2.7% rise today. Here's how the six largest banks have done (note that all six were part of the 19-bank stress test):

Company

Return since Monday's Close

Return Today

Bank of America

15.6%

4.5%

JPMorgan Chase

10.3%

2.6%

Wells Fargo

8.1%

2.1%

Morgan Stanley

7.2%

4.9%

Citigroup (NYS: C)

5.8%

3.0%

Goldman Sachs (NYS: GS)

5.2%

2.2%

Note that even Goldman Sachs, which has been dealing with the resignation letter from hell, is up. So is Citigroup, which failed one part of the stress test (but only because it got too aggressive in asking for higher dividends and share repurchases) and will have to resubmit its capital plan later this year.

Why has the market responded so favorably? I believe it's because the stress tests weren't the watered-down tests we've seen from the U.S. and Europe in the past. For its worst-case scenario, we're talking 13% unemployment, a Dow that falls under 6,000, and a housing market that crashes 21%. Even in that scenario, every bank but Ally Financial exceeded the Fed stress-test minimum 5.0% Tier 1 common capital ratio, if dividends and share repurchases are restricted.

So you can thank the Fed for conducting a plausible stress test and publicizing the robust results bank-by-bank for this banking rally. In an industry with little balance-sheet visibility, this was a step in the right direction.

At the time this article was published Anand Chokkaveluowns shares of Bank of America, Citigroup, Wells Fargo, and JPMorgan Chase. He also owns long-dated options on Bank of America and warrants on Citigroup, Wells Fargo, and JPMorgan Chase.The Motley Fool owns shares of JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup. The Fool owns shares of and has created a covered strangle position in Wells Fargo.Motley Fool newsletter serviceshave recommended buying shares of The Goldman Sachs Group. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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