Banks start 2012 with a bang. Why?

@lamonicabuzz January 3, 2012: 1:18 PM ET
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Bank stocks had a brutal 2011, led by a gruesome drop in shares of Bank of America. But the sector may not rebound in 2012.

NEW YORK (CNNMoney) -- Big bank stocks ushered in the New Year by doing something they rarely did in 2011 ... leading the market higher.

Bank of America (BAC, Fortune 500), which was the Dow's biggest loser last year with a nearly 60% drop, surged more than 4% Tuesday. Goldman Sachs (GS, Fortune 500) was up about 5% while Citigroup (C, Fortune 500) and Morgan Stanley (MS, Fortune 500) each gained more than 6%.

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So will this be a big comeback year for bank stocks? Probably not.

Sure, they may not plunge another 25% like the KBW Bank Index (BKX) did last year. But many investors are still skeptical about the sector for obvious reasons. Europe's debt woes are not over. The U.S. economy, while showing signs of gradual improvement, remains stuck in slow growth mode.

It's also still not clear how much of a negative impact the new government rules that are part of the Dodd-Frank Wall Street reform act will have on the largest financials.

And several big banks, most notably BofA, still have legal risks and concerns about capital tied to mortgages that went bad during the credit crisis of 2008.

That prompted Joe Saluzzi, a partner at Themis Trading, to tweet Tuesday morning that "$BAC should just request a trading halt for the rest of the year and call it a win."

The best you can say about many large banks right now is that they are cheap. But that doesn't matter if the fundamentals remain weak.

In a report Tuesday morning, analysts at Keefe Bruyette Woods, a boutique financial services research firm (and the KBW in the KBW Bank Index) wrote that "economic uncertainty and fears of global financial contagion are likely to hold down valuations and revenues over the near term" for Wall Street banks.

Banks are healthy ... and other bad predictions of 2011

The KBW analysts also cut their fourth quarter earnings forecasts and stock price targets for Citi, JPMorgan Chase (JPM, Fortune 500), Goldman and Morgan Stanley, citing expected declines in investment banking and trading activity.

"This continued trend in reducing estimates is typically never good for stocks," the KBW analysts added.

The problem that investors have with the largest banks is that even if you have an MBA or Ph.D in economics, it's difficult to ascertain the true value of the complex assets on their balance sheets. Heck, some would argue you need an M.D. to diagnose what's ailing the likes of BofA and Goldman.

That's why some money managers think that smaller, regional banks are better investments if you believe the U.S. economy is really on the mend and that financial stocks should get a corresponding lift.

It's easier to understand banks that stick to the tried and true business of lending money and taking in deposits and don't have things like sovereign debt exposure to Italy and massive proprietary trading desks.

"There are a lot of clouds for bigger banks, Europe is still an issue and government regulations are voluminous to put it mildly," said Andrew Boord, senior research analyst with Fenimore Asset Management in Cobleskill, NY.

What's more, some of these smaller institutions have taken advantage of the turmoil in the financial markets and are growing by taking over failed banks.

The weekly Friday ritual of checking out what banks went under over on the FDIC web site didn't get as much attention in 2011 as it did in 2008. But many smaller lenders did fail last year, and that allowed banks with healthy balance sheets to gain more customers on the cheap.

"We like smaller banks that have been strong enough to take advantage of opportunities and acquired failed banks," Boord said.

He pointed to two Arkansas-based banks, Bank of the Ozarks (OZRK) and Home BancShares (HOMB), as perfect examples of smaller lenders that have done well the past few years thanks to this strategy.

Buffett and Paulson lose on BofA bets

Bank of the Ozarks has scooped up failed banks in Georgia while Home BancShares acquired several shuttered banks in the Florida panhandle region. Boord, whose firm owns both stocks, also likes SCBT (SCBT), a South Carolina bank that has bought failed banks in Georgia.

Now it's great to see that smaller banks are doing well. Americans love an underdog after all.

But let's be honest. Even though we may love to hate big banks for their insane fees, obscene bonuses and addiction to risk, we need the larger financials to join their smaller counterparts for more than just a day or two if we want the overall market to do well in 2012.

"I prefer to see the leading sectors of the economy lead the market -- that means financials," wrote Barry Ritholtz, CEO of Fusion IQ, a New York-based research firm, in a blog post Tuesday.

"The bottom line is this: These rallies are for traders, not longer term investors," he added.

Sounds a lot like last year. By the way, you may not remember that BofA stock soared more than 6% on the first trading day of 2011 after the bank announced a settlement with Fannie Mae and Freddie Mac over bad mortgage loans. In fact, the whole sector rallied. The KBW Bank Index rose more than 2%.

Oops.

Best of StockTwits: Should old Twitter acquaintance be forgot and never brought to mind? Of course not! Tuesday's big rally had many ringing in the new year for the markets in 140 characters or less.

CreateCapital: Money OUT of bonds and INTO stocks. Happy New Year!

Yup. Risk is back. For now. It could all change tomorrow. Or by 3 today when the robots take over.

traderstewie: DO NOT chase this. If this is for real, you will see PLENTY of opportunities to get into stuff within a few days.

Totally agree, Stewie. Although why are you always trying to kill your mother? Anyway, as is the case with most parties, it's usually better to be a little late than too early. (So says the parent of a two-year old who couldn't even make it to midnight on New Year's Eve.)

conorsen: $GOOG, for my money the best bellweather in the world, is closing in on a 4-year high.

This is great to see. I've long been a fan of Google (GOOG, Fortune 500) because it's a great case of a top-notch company that doesn't play the silly Wall Street short-term expectations game. It's managing for the long-term. And that's paying off.

Of course, there are other tech stocks that aren't faring as well.

ReformedBroker: Rather than replace the CEOs, $RIMM is said to be leaning toward some type of animal mascot, possibly a Moose of some sort...

Ha! Maybe RIMM (RIMM) could borrow Quatchi, one of the mascots from the Vancouver 2010 Winter Olympics? It might be easier to find a Sasquatch than a happy RIMM shareholder.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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