What stocks are doing best in a very good year for the market?
In many cases, the answer is bank stocks. Yes, you know, banks? They take deposits and sometimes even make loans.
Banks would not be an obvious choice as a hot stock market sector with the economy poking along at an agonizingly slow pace.
Remember last month, when Federal Reserve policymakers were so concerned they launched yet another stimulus plan to help the economy avoid a complete stall?
But banks of all kinds have been favorites of stock investors for a solid year now.
That includes giants like Bank of America Corp. (up 68 percent so far in 2012) as well as little guys like Hingham Institution for Savings (up 45 percent) and the holding company for East Boston Savings Bank (up nearly 43 percent).
The leading bank-stock index, which tracks the shares of 24 large US institutions, has advanced 30 percent so far this year. By way of comparison, the broad Standard & Poor’s 500 index is up 14 percent.
The quarterly earnings season for banks begins Friday with reports from JP Morgan Chase and Wells Fargo & Co. Analysts expect mostly good news, which could give the stocks another boost in the short-term.
So how do hot bank stocks make sense in a tepid economy?
The answer starts with good timing. Investors had been selling bank stocks through the summer and early fall of 2011 when everyone was worried about big trouble in Europe and a possible double-dip recession in America.
Those stocks hit bottom in November of 2011, or close to one year ago.
“Then the market started to figure out the US wasn’t going into a recession,” says Gerard Cassidy, a bank stock analyst ar RBC Capital Markets. “More importantly, it also figured out the housing industry had finally turned.”
At this point, it’s clear the housing sector really is gaining momentum.
Investors have responded by buying shares of home builders such as PulteGroup Inc. (up 149 percent this year) and home appliance stocks like Whirlpool Corp. (up 79 percent).
But banks represent by far the biggest sector of the stock market that offers investors exposure to an improving housing sector. In fact, banks are making lots of money in the mortgage business — and not only by financing purchases of new homes.
They are processing piles of home-refinance loans thanks to incredibly low mortgage rates influenced by those Fed policymakers trying to spark a faster economic recovery.
Meanwhile, most banks have worked through the worst of their bad-loan problems. Rather than setting aside piles of money from earnings as a cushion against possible loan losses — as banks did after the economy tanked — some big institutions are reversing the process.
Now they’re pulling money out of reserves and counting the saved money as profits.
The Wall Street Journal estimates 23 percent of the pre-tax profits recorded by the nation’s four largest banks over the past year were in fact funds withdrawn from loan-loss reserves.
That practice could change, or at least slow down in the near future if regulators decide it’s too risky for banks to deplete their reserves so quickly. But banks no longer need to divert large chunks of their profits as new contributions to those loan reserves.
Banks of all kinds in Massachusetts managed through the recession with relatively few bad-loan problems and now boast portfolios with nearly pristine credit quality.
As a group, Massachusetts banks suffered loan losses equal to just 0.03 percent of all loans in the second quarter of this year, according to data compiled by the Federal Deposit Insurance Corp. That’s an extremely low loss rate in any kind of economy, amounting to just $300 for every $1 million in outstanding loans.
After their strong performance over the past year, bank stocks are still modestly less expensive than the broad market if you measure share prices in relation to corporate earnings. Cassidy believes bank stocks would climb another 30 percent if the industry boosted its below-average profits back to historical norms.
The rebound by banks and their stocks certainly isn’t complete. One caveat: The timing and pace of recoveries — in the economy and stock market sectors — are hard to predict.
But banks have emerged as some of the stock market’s brightest stars of this year.