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Dow Back in Bull Mode; Banks Rise, Pass Stress Tests

By Dan Caplinger – Mar 20, 2014 at 9:00PM

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After a big drop Wednesday on concerns about interest rates, the Dow clawed back some gains Thursday morning, as positive signs of economic growth emerged.

Yesterday, many investors feared that the Dow Jones Industrials (^DJI 0.23%) might have seen its best days, after concerns over Chairwoman Janet Yellen's vision of when the Fed might start to raise interest rates sent the average down more than 100 points. But Thursday, the Dow clawed back all but five points of yesterday's losses, and two positive factors could keep the Dow climbing tomorrow: positive reads on U.S. economic activity, and the fact that all but one major bank passed the Fed's stress tests, including Dow components JPMorgan Chase (JPM -0.27%), Goldman Sachs (GS 0.38%), and American Express (AXP 0.01%).

On the macroeconomic front, popular leading economic indicators pointed toward further expansion in the second half of 2014, and gave investors confidence that the long winter and its impact on growth wouldn't hold back long-term expansion. That's good news for several Dow components that have struggled to sustain revenue growth, with higher profits coming more from cost-cutting and profit-margin increases than from greater sales. Without continued economic expansion, it'll be increasingly difficult for stocks to sustain their bull-market rally throughout a sixth year.

For the Dow's financials, the positive news from the Fed about their stress tests was welcome. The only one of the 30 banks to fail the stress test was Zions Bancorp (ZION -8.87%), which fell prey to a simulation of a deep recession like the financial crisis of 2008. Yet, even Zions passed capital threshold requirements in a simulated rising-interest-rate scenario, which is much more likely to occur in the near future. Overall, the Fed said that big banks are in much better shape than they were five years ago at the height of the crisis, and that's indicative of the moves that they've made to shore up their capital and change the level of risk they take on in their business practices.

Thursday was a good day even before stress-test figures came out after the bell. JPMorgan climbed more than 3%, with the sale of its commodities-trading group allowing it to add another $3.5 billion in capital to its banking operation and eliminating a significant potential source of liability from its core operations. In general, shareholders have applauded moves from JPMorgan, Goldman, and other banks to simplify their operations and manage risk more closely.

Still, not everyone's convinced that banks are out of trouble just yet. Earlier this week, former FDIC Chairwoman Sheila Bair argued that bank capitalizations are still far too low, especially given that the industry is at a high point in its business cycle at the moment. Bair would have banks take on even less leverage, which would be a threat to the business models that JPMorgan and Goldman and, to a lesser extent American Express, have taken in response to the crisis.

For the Dow to keep rising, financial stocks will need to lead the way. Positive stress-test results give one more data point showing how far they've come in just a few short years.

Dan Caplinger owns warrants on JPMorgan Chase. The Motley Fool recommends American Express and Goldman Sachs. The Motley Fool owns shares of JPMorgan Chase. 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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