Do I sell my bank stocks ahead of stress test results?

Posted May 6th 2009 12:10PM by Melly Alazraki
Filed under: Bank of America (BAC), Goldman Sachs Group (GS), Wells Fargo (WFC), Financial Crisis

If you're like me and you bought some bank stocks after they plunged -- to trade or as a short-term play -- you have likely made a handsome profit so far.

You're probably also wondering, then -- should I sell my bank stocks ahead of the stress test results? I've been toying with this question for a few days now, watching sentiment carefully.

No doubt, some of the results will be awful, but I want to believe the market knows this. In a way, it's like earnings estimates. If Apple (NASDAQ: AAPL) beats estimates by a penny, it won't satisfy investors. If it beats the whisper number, investors will be much happier. Similarly, this past earnings season turned out to be generally better-than-expected, as expectations were really low.

So if investors expect the worst come tomorrow, then it's mostly priced in. But if investors somehow expect -- and I doubt this -- better outcomes from the stress test, then it's possible we'll see financials decline. Still, from news reports it seems the stress test took into account the worst case scenarios for the economy, and lately the economy has been showing some signs of stabilizing -- at least the rate of decline has improved markedly. That is definitely something that could continue to drive optimism regarding banks.

Just look at what's going on with Bank of America (NYSE: BAC) today: despite reports it may be required to raise $34 billion in additional capital, and despite an earlier decline of over 9%, BAC shares now trade around $11.80 -- a 9% gain -- following a better-than-expected jobs report, but probably mostly on hopes for better clarity (investors despise uncertainty).

Another problem for stock holders of some banks is that a dilution is also a possibility, depending on where the extra capital is coming from.

Taking all that into account, the likely outcome tomorrow is that the reaction will be specific to those banks that performed far better or worse than expected on the stress test, rather than a general reaction across the sector. If you happen to own one of those banks tomorrow, that's the risk you're taking -- for better or worse. If you hold Wells Fargo (NYSE: WFC) and it is actually required to raise less capital than is now expected, then its stock might soar; and if Goldman Sachs (NYSE: GS) somehow fares worse than it is expected, then it might slump.

Personally, I didn't buy into the banks long-term, and I think I just might cash in today.

Disclosure: Long Bank of America

Tags: bac, featured, gs, wfc