How a Dow Swoon Could Help Bank of America and Citigroup

You have to look past the stock market to see how macroeconomic factors affect various businesses.

Apr 8, 2014 at 12:30PM
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The Dow Jones Industrials (DJINDICES:^DJI) overcame an initial drop Tuesday to climb 32 points into the green as of 12:30 p.m. EDT. By looking at how other financial markets reacted to the declines in the Dow Jones Industrials over the past few days, we can gauge how their crosscurrents could help certain stocks. One example is the bond market, in which Bank of America (NYSE:BAC), Citigroup (NYSE:C), and a host of other financial institutions have a huge vested interest.

How bonds fared during the Dow downturn
The two-day drop in the Dow Jones Industrials on Friday and Monday cut about 2% off the average, with other benchmarks like the tech-heavy Nasdaq declining almost 4%. Even the hint of a correction drove investors away from momentum-driven stocks, with Bank of America falling 4.5% after having seen some huge gains over the past year and a half.

Bonds

But elsewhere in the financial markets, bond prices actually rose in response to the Dow's downturn. Whether you were looking at Treasuries, corporate bonds, or municipal bonds, you could find decent gains as interest rates fell slightly, maintaining their current low levels despite the gradual withdrawal of the Federal Reserve from its quantitative easing activities. It's reasonable to expect that if the Dow's recent losses extended into a full-blown correction, bond yields would continue to ease lower, boosting returns for bond investors and signaling the latest in the ongoing tug-of-war between stocks and bonds for investment supremacy.

What bonds mean for banks
Although stock and bond prices tend to move in opposite directions when you're looking at the broad market, certain stocks can benefit from a strong bond market. In particular, one big concern for banks has been that rising interest rates have dried up the important revenue source from mortgage originations, which bring in fee income as banks process loans for customers and then sell them to government-sponsored enterprises to be packaged into mortgage-backed securities and sold to investors. As mortgage lenders, Bank of America and Citigroup stand to gain from higher originations that could result from lower rates.

But that's not the only way that Citigroup and Bank of America could benefit from an attractive bond market. During the first three months of 2014, Citigroup led all underwriters of U.S. municipal bonds, raising more than $8 billion for state and local governments. Bank of America's Merrill Lynch was the next highest, underwriting more than $6 billion in bonds. Although competing banks often take a bigger share of the corporate bond market, Citigroup and Bank of America still rank near the top.

Obviously, interest rates and the bond market aren't the only thing driving performance at Citigroup, Bank of America, and other U.S. banks. But the more important lesson here is that when you see certain movements in financial markets, you need to remember the interaction between those markets and how they'll affect the individual stocks you own. In some cases, the same issues that might help send the Dow Jones Industrials to a long-awaited correction might be exactly the ones that can boost the long-term fundamentals of companies in your portfolio.

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Dan Caplinger owns warrants on Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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