Short Sellers See a Rebound Coming for Big Bank Stocks

Short Sellers See a Rebound Coming for Big Bank Stocks
Short Sellers See a Rebound Coming for Big Bank Stocks

Investors have generally taken a negative position on the prospects of big banks lately. The major financial institutions face new capital requirements pushed by the FDIC, a decrease in revenue from credit card fees, and serious mortgage woes due to their questionable foreclosure and record-keeping practices. Many have also had to sell or spin off their proprietary trading desks due to provisions of the Dodd-Frank Financial Reform Act -- operations that have often been highly profitable.

However, some of Wall Street's most carefully watched investors -- short sellers -- have begun to withdraw their bets against big banks. It appears, based on their new positions, that they expect shares in the financial companies to rally. Data from the NYSE on short interest for the period that ended May 27 shows that the short position in Citigroup (C) fell by 13% to 42 million. Shares sold short in Bank of America (BAC) dropped 12% to 84.8 million. The short interest in J.P. Morgan Chase (JPM) shrank 16% to 29.6 million.

The impetus for this trend away from betting that bank shares will drop further may not be a belief that bank earnings will rise or that their troubles will evaporate. The issue may simply be that their shares have already fallen so far so fast.

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Citigroup shares are off 14% in just the last month and trade at $37.77 near their 52-week low of $36.20. A reverse split meant to lure more institutional investors into the stock hasn't worked. Bank of America shares are down 13% over the last month to $10.65, very near their 52-week low.

J.P. Morgan's shares are off 9% over the last month. The bank's well-known CEO, Jamie Dimon, recently complained aggressively and publicly to Fed Chairman Ben Bernanke that new regulations would hurt bank earnings, and thus reduce their willingness to loan money in a choppy economy.

And the Treasury Department is punishing Bank of America, J.P. Morgan and Wells Fargo (WFC) for failures to follow the implementation rules for the government's Home Affordable Modification Program, intended to encourage banks to modify mortgages and keep distressed homeowners in their houses.

If short sellers are right, bank stocks will rise soon. But shorts rarely make long-term bets, so even if they are right, the share price gains could be temporary.

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