The Dow's Hottest Stock: How Long Can Its Incredible Winning Streak Last?

The Dow Jones Industrial Average (INDEX: ^DJI) is up an impressive 5% so far in 2012. But that's peanuts compared with the gain enjoyed by its biggest winner so far this year.

Bank of America (NYS: BAC) is up an incredible 45% in a few short weeks. But can its hot streak continue?

Three major factors account for BofA's huge gains.

First, let's keep things in perspective. Shares are rebounding after a 58% loss in 2011. Part of the selling toward the end of 2011 and subsequent buying in early 2012 undoubtedly had to do with investors who were selling their losers to capture tax deductions, and institutional investors who were selling their losers so their portfolios would look better to their bosses and investors at year-end reporting. Although momentum can continue to carry stocks, six weeks into the new year, it's unlikely that this factor will continue to propel BofA.

Second, banks -- particularly troubled banks like BofA -- are economically sensitive. An improving economy means more attractive opportunities for loan growth, a greater likelihood that old borrowers will be able to repay, and better trading and investment-banking results. With reasonably good employment and manufacturing data coming out so far this year, economically sensitive stocks such as Alcoa and Caterpillar have been top Dow performers as well.

Finally, bank investors are licking their chops after it was announced on Thursday that BofA, Citigroup (NYS: C) , JPMorgan Chase (NYS: JPM) , Wells Fargo (NYS: WFC) , and Allied Financial had settled with federal and state prosecutors over widespread allegations of fraud in the mortgage-servicing industry.

The settlement should be presumed to be favorable to the banks, because (1) a full investigation never actually took place, (2) banks can pay a portion of the settlement with investors' money, rather than their own, (3) homeowners whose homes were wrongfully taken from them are only eligible to receive some $2,000 from the settlement, and (4) the actual terms of the deal will reportedly be kept from the public until the latest possible date.

Despite the fact that "the cost of doing business" here appears to be relatively small, that doesn't mean banks are totally in the clear so far as the law is concerned. For one thing, the actual settlement terms don't even exist yet, so the deal could conceivably fall apart again before it's inked, though that's unlikely.

Although we won't know until the details are made public, reportedly, the settlement won't cover liabilities over how mortgages were bundled during the financial crisis, nor will it cover MERS (the fake electronic mortgage-tracking system banks used to track mortgages) or prevent homeowners or private investors from suing banks.

In short, the settlement appears to be about a lump payment plus some mortgage-debt relief in exchange for letting banks off the hook for potentially widespread forgery, document fabrication, and mistreatment of borrowers. But what's unclear is whether the settlement will inhibit prosecution of the aforementioned liabilities. If it does, and the recovery is for real, bank investors could be in good shape. If it doesn't, and the economic recovery isn't as strong as it appears, they could be in for a wild ride.

If you're looking for some safer, less convoluted stocks, I'll point you to my colleague Anand Chokkavelu's top banking picks. He details them in our brand new free report: "The Stocks Only the Smartest Investors Are Buying." It includes one that's the kind of stock even Warren Buffett might have been interested in during his earlier years. I invite you to grab a free copy.

At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned. The Motley Fool owns shares of Wells Fargo, Citigroup, Bank of America, and JPMorgan Chase and has created a covered strangle position on Wells Fargo. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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