Financial stocks have rebounded sharply since March as evidenced by the S&P 500 financials index performance. But will this run continue? That is the $64,000 question, and the jury is still out.

Bulls will likely suggest that as the economy rebounds and America moves forward, the outlook for financials should improve as well. I generally agree. Some might also argue that with the stress tests now behind us, the group is free to run.

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At the same time, I don't think the economy or banks will experience a straight trajectory upward. I'm betting the road will be bumpy, which is why I'm cautious.

Let's Take A Closer Look At Some Big Names:
Bank of America (NYSE:BAC)
I think this stock has potential over time. After all, this company has so many moving parts and things that can help people. For example, it has traditional banking products like checking accounts, it has its hands in credit cards and investments, and it makes loans. I think that longer-term, as individuals and businesses look to grow their wealth, these products and the company will play a big role.

However, some negatives shouldn't be overlooked. For example, the stock has bounced back appreciably from under $4 in March to more than $12 as of May 12. My gut tells me that some profit taking could be in the cards. To boot, investors may start looking at valuation and notice that the company currently trades at a pretty high price-to-expected-earnings ratio. Note that the North Carolina-based bank is expected to earn 47 cents per share in 2009 and $1.17 a share next year. This, too, leaves me worried that the share price could be vulnerable.

Finally, I'm worried about the lack of a catalyst in the near term. In my opinion, this stock saw its bounce mainly because it became evident that the government would likely backstop big-name firms. But what will drive it now? I don't think the prospect for near-term earnings will be a big motivator.

Citigroup (NYSE:C)
Long term, this financial services company has a great deal of potential. Its vast footprint is a huge asset. According to its website, its "350,000 employees manage 200 million customer accounts across six continents in more than 100 countries." I also think the government will probably not let these guys go under.

However, Citi trades under $5, and that could be a major impediment as some investors won't entertain an investment below that threshold. I'm also concerned because the company is expected to lose money both in 2009 and 2010. Frankly, I'd feel more comfortable waiting until profits are expected to be just around the corner before jumping in.

JP Morgan Chase (NYSE:JPM)
This stock could do well over the longer term. The company is expected to post what I would call big profits this year and next. It's expected to earn $1.48 a share this year and $2.71 in 2010. That means it trades at what I think is a reasonable 12.8 times the 2010 estimate.

It also has Jamie Dimon at the helm. He's a straight shooter, and when he talks, people tend to listen. He has held other high-profile positions, at Citigroup for example, and he was even on Time's 100 Most Influential People list in 2008. Dimon was also smart and savvy enough to pick up Bear Stearns on the cheap.

So You Have An Opinion About Financials?
An interesting way to make a wager on financials would be to purchase shares of Direxion Financial Bull 3x Shares ETF (NYSE:FAS). According to its site, the Financial Bull 3X Shares seeks daily investment results, before fees and expenses, of 300% of the price performance of the Russell 1000 Financial Services Index. This could prove to be an interesting investment for those who want to bet on a continued rally in the sector.

Another possibility for those who don't expect the momentum in the financial sector to continue may be to purchase shares of Direxion Financial Bear 3x Shares (NYSE:FAZ). According to its site, the Financial Bear 3X Shares seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the price performance of the Russell 1000 Financial Services Index. (For more, see Dissecting Leveraged ETF Returns and Singling Out Sector ETFs.)

Bottom Line
Bank/financial stocks have enjoyed a nice little run. In the long term, I think they have solid upside potential as the economy emerges from this recession. But in the near-term, the key word is "caution".

For further reading, see The Evolution Of Banking and Choose To Beat The Bank.

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Tickers in this Article: JPM, C, BAC, FAS, FAZ

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