Why Bank of America Crushed the Dow Today, and How to Profit Tomorrow

The Dow Jones Industrial Average (INDEX: ^DJI  ) had a pretty good day. The index closed up 0.52% on investor optimism that the German constitutional court will vote in favor of the European Stability Mechanism tomorrow and that the Federal Reserve will soon release a third round of quantitative easing, following vaguely encouraging language from Chairman Ben Bernanke after the Jackson Hole, Wyo., symposium last month.

However, the Dow got absolutely crushed by Bank of America (NYSE: BAC  ) which cruised 5.2% higher today. The reasoning is clear: If the Fed keeps rates low at its meeting starting tomorrow, or provides extended guidance about how long rates will be kept low, banks win.

Having supernaturally low interest rates creates an environment for previously battered banks to shore up their balance sheets and build a better foundation for long-term profitability. With the U.S. adding only 96,000 jobs in August and the unemployment rate still stubbornly stuck above 8%, it's unlikely the Fed will do anything that could extinguish the recent flicker of growth from our economy, and will probably try to stoke the coals with a little extra QE fuel.

How to play it
A massive flooding of money into the economy paves the way for inflation, though, and can quickly reduce the viability of certain investments. One way to combat that risk is with exposure to the energy sector, which has historically protected against inflation. I remain very bullish on the energy sector, and I see a long runway of profits for the patient investor.

According to Factset, the energy sector has a 66% buy rating by analyst now, the highest of any sector on the S&P 500 (INDEX: ^GSPC  ) . This trend has held for an amazing 16 months, indicating long-term enthusiasm about the space. Of particular interest are services plays Halliburton (NYSE: HAL  ) and Schlumberger (NYSE: SLB  ) . Both have innovative products to increase recovery rates, as well as strong reputations within the space as expert operators.

As rapidly growing economies like China and India see a spike in energy demand, they are increasingly awarding these companies key services contracts and using their expertise in the space. Of the two, Schlumberger appears better positioned for growth abroad. The company continues to win key contracts, and even manages whole oil fields in essential energy markets like Russia. This comes at a premium, though, as the company trades for more pricey multiples than peer Halliburton.

Don't stop now
Both the finance and energy spaces appear poised to pop contingent on the Fed's decision, and I think investors should have exposure to the best plays in each space.

To learn about why Bank of America's pop today is just the beginning of what could be huge returns, read our top finance analyst's premium research report. You'll learn about the three key areas you must watch, and why to buy and sell.

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Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of Halliburton. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On September 11, 2012, at 8:35 PM, Rusty56 wrote:

    Austin, come on help me out here. You are making the point that if interest rates stay low it helps the banks while most analyst disagree saying low rates hurt their profit margins which I tend to agree with. Can't have it both ways my son.

  • Report this Comment On September 11, 2012, at 9:31 PM, TMFBWItime wrote:

    @ Rifleman5779

    While we have seen overall rates decline, the yield spread is still wider than the historic average. So while consumer rates have dropped, the rates banks borrow at has dropped faster. That extra range has allowed banks to shore up their balance sheets, which we've seen them do recently.

    Thanks for the comment, Fool on!

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