At least seven of the 10 banks considered by the government to be inadequately capitalized, as well as two others that were found to have sufficient capital cushioning, announced fund raising plans following the release of the stress test results.

PNC Financial Services Group Inc. (NYSE: PNC), U.S. Bancorp (NYSE: USB), KeyCorp (NYSE: KEY), Citigroup Inc. (NYSE: C), Morgan Stanley (NYSE: MS) Wells Fargo & Co. (NYSE: WFC), and Bank of America Corp. (NYSE: BAC) all announced stock offerings or asset sales in the past week.

BB&T Corp. (NYSE: BBT) and Capital One Financial Corp. (NYSE: COF), which were deemed by the government to be sufficiently capitalized, have also announced stock offerings.

Still, S&P says the banks, which have will continue to struggle without a bigger capital cushion than regulators require.

“There’s nothing to say that this banking crisis can’t go on for another three or four years,” S&P Managing Director Tanya Azarchs said.

S&P on May 4 said it might lower its ratings for 23 U.S. banks and thrifts, including 10 that underwent stress tests, citing concern about the industry’s capitalization, Reuters reported. It said the 23 companies had at least a 50% chance of being downgraded within 90 days.

Source: Standard & Poor’s Says Banking Crisis Has Entered New Phase

U.S. banks – under government order to raise capital as a result of the recently completed bank stress tests, and desperate to shed the onerous shackles of the U.S. Treasury Department’s Troubled Assets Relief Program (TARP) – have been announcing billions in secondary stock offerings in recent days, and experts say many more such deals can be expected.

Anadarko Petroleum Corp. (NYSE: APC), Bank of America Corp. (NYSE: BAC) and Ford Motor Co. (NYSE: F) yesterday (Tuesday) became the latest U.S. companies to pursue new sources of capital, announcing deals that involved offerings of stock or debt, or outright asset sales.

Those announcements came just one day after four of the largest U.S. banks – BB&T Corp. (NYSE: BBT), Capital One Financial Corp. (NYSE: COF), U.S. Bancorp (NYSE: USB) and KeyCorp (NYSE: KEY) – announced plans to raise a combined $6.5 billion through stock offerings. At least some of the money raised will be used to repay the TARP money the federal government injected into troubled U.S. banks.

“All the deal activity sends a clear signal – investors are willing to take more risk,” says Louis Basenese, a longtime expert on the IPO market and editor of The Takeover Trader and White Cap Report newsletters. “And it’s already trickling down into the IPO space. In the next two weeks, four deals are slated, doubling the total volume for 2009.”

When asked if all these deals could end up soaking up all the capital that’s still sitting on the sidelines – blunting, as a result, the rally that’s had stocks surging over the past two months – Basenese said there’s no reason for that to be a concern.

“With $8 trillion-plus on the sidelines, we’ve still got a ways to go before the capital is gone,” Basenese said.
In fact, we may well be just getting started, he says.

“During slowdowns, the IPO space is as lonely as a geek on prom night. But right now, our geek might be getting lucky. Along with the market rally and strong appetite for secondary offerings, we’re seeing IPOs hit the market again,” Basenese said. “This week we get Digital Globe. Next week, OpenTable and SolarWinds are slated to debut. And there are over 100 more in the pipeline to fuel a sustained recovery.”

The Latest Deals

Yesterday’s announcements involved a carmaker, an energy company and a top U.S. bank.

Anadarko, an independent oil-and-gas exploration and production company based in Woodlands, Tex., said yesterday that it priced a public offering of 30 million shares at $45.50 each. Underwriters have an option to buy up to 4.5 million additional shares of the company’s common stock through the offering, which is expected to close Friday.

The company’s shares were down about 6% and listed at $45.70 in pre-market trading yesterday morning, FoxBusiness.com reported.

Bank of America, ordered to find $33.9 billion in new capital as a result of the recent bank stress tests, has finally sold about $7.3 billion worth of its shares in China Construction Bank Corp., Reuters and Bloomberg News both reported.

BofA sold 13.5 billion shares, or 6% of CCB, to investors including Hopu Investment Management Co. and Singapore sovereign wealth fund Temasek Holdings Pte. The sale cuts Bank of America’s stake in CCB to 10.6%.

Hopu Investment was founded in 2007 by Fang Fenglei, Goldman Sachs Group Inc.’s (NYSE: GS) China partner. Hopu and Temasek have collaborated before; in late April, the two announced plans to invest $300 million in a Mongolian iron-ore mine. It was Hopu’s first deal since being launched as a private equity firm, Bloomberg News reported.

Bank of America’s sale of part of its CCB stake wasn’t news to Money Morning readers. In a story published in mid-January – “The Global Financial Crisis Will Cost Western Banks a Share of Future China Profits” – Money Morning reported that BofA was going to have to sell some of its stake in that key China bank. Indeed, the report detailed how banks in the United States and Europe would have to divest their interests in China’s promising banking market in order to close capital deficits created by the global financial crisis. The story was part of Money Morning’s ongoing investigation of the U.S. banking bailouts.

On Friday, BofA filed with the U.S. Securities and Exchange Commission (SEC) to sell as much as 1.25 billion shares of common stock, a move that would raise as much as $11 billion (given a proposed maximum offering price of $8.79 per share).

BofA said it will use the net proceeds from the offering for general corporate purposes. Bank of America Securities LLC and Merrill Lynch & Co. (NYSE: SQD) were listed as the underwriters for the stock offering.

Bank of America is also looking at still more asset sales to raise the rest of the required capital. Last Thursday the bank said it’s looking to end a loss-sharing agreement with the federal government on $118 billion of troubled assets, calling the agreement unnecessary – and too expensive.

Ford announced plans to sell 300 million common shares, and said it would use the proceeds from the offering for “general corporate purposes,” and to make a contribution to a fund that pays for healthcare for its retirees.

Total shares outstanding will increase to 3.102 billion – or to 3.148 billion if underwriter’s option for an additional 45 million shares is exercised.

Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM) and Morgan Stanley (NYSE: MS) are acting as joint managers for the stock offering.

Ford’s shares closed yesterday at $5.01, down $1.07, or 17.6%, from Monday.

According to an SEC filing, a settlement with various unions calls for the initial three payments to be made on Dec. 31, 2009, June 30, 2010 and June 30, 2011. At each date, as much as $610 million of the amounts payable could be satisfied by the delivery of Ford common stock, valued at fixed prices of $2.00, $2.10 and $2.20 per share, respectively, the filing stated.

Ford intends to use a portion of the proceeds of this offering to fund all or a portion of the payments to the settlement fund – in lieu of delivering shares on those payment dates, according to a media report by 123Jump.com.

Ford Chief Executive Alan R. Mulally took advantage of the stock-offering announcement to say that Ford’s management and employees are making “strong progress on our transformation plan – gaining retail market share with great new products, improving quality, reducing costs and positioning Ford for a return to profitability.”

Ford also said that it’s unlikely the company will pay any dividend in the foreseeable future. Ford last paid dividends in the third quarter of 2006.

As Ford Sells Shares, So Do GM’s Top Execs

Interestingly, Ford is trying to sell shares to investors just as a group of top General Motors Corp. (NYSE: GM) executives – including GM Vice Chairman Robert A. “Bob” Lutz – have sold what was left of their personal stakes, according to several SEC filings on Monday. The stock sales by GM executives were reported by MarketWatch.com.

“Our shareholders are obviously facing some pretty severe dilution if the bond exchange goes through or we end up in bankruptcy,” GM spokesperson Julie Gibson told MarketWatch. “Either way, no matter the outcome, we’ll essentially be issuing new stock.”

She acknowledged to MarketWatch that the executives took advantage of a trading window to sell their shares while there’s still some value “like most reasonable people would do.”

GM’s executives sold their shares just as the company is trying to rid itself of $27 billion in debt by persuading thousands of creditors to exchange their bonds for 10% in GM stock.

According to the MarketWatch report, the SEC filings say that Lutz was joined by fellow Vice Chairman Thomas G. Stephens, Ralph J. Szygenda, Troy A. Clarke, Gary L. Cowger and Carl-Peter Forster. All together, the six sold nearly 205,000 shares between Friday and Monday, fetching between $1.45 and $1.61 a share.

GM’s shares closed yesterday at $1.15 each, or 20.14%.

It is worth noting that Money Morning Contributing Editor Martin Hutchinson wrote this week that there’s a chasm of difference between the prospects of GM and Chrysler LLC – the two foundering members of Detroit’s “Big Three” – and Ford, which Hutchinson says may actually be worth investing in.

If the market shakes out as Hutchinson expects, Ford could emerge as only real winner among the U.S. automakers.

Under such a scenario, “Ford will pick up market share from GM and Chrysler, even if domestic brands overall continue to see their market share ebb,” Hutchinson wrote. “That will reduce Ford’s losses, and when the automobile market does rebound, the company that created the original automobile assembly line will move to a position of substantial profitability. For the first time since Henry Ford kept the Model T in production too long in the 1920s, Ford may become the dominant U.S.-controlled automobile manufacturer.”

As the secondary-offering market heats up, and the recession, Basenese, the stock-offering expert, says investors need to focus on these investment opportunities – and especially on those that emanate from the expected escalation in IPOs.

“History suggests IPOs are the place to invest coming out of a slump,” he said. “For proof, all we need to do is go back to the last ’severe’ recession on record, from 1973 to 1975. As we exited, IPOs turned in impressive numbers, with first day gains jumping to 40% and three-year returns climbing to more than 150%, easily outpacing the Standard & Poor’s 500.”

Source: Big Surge in Secondary Stock Offerings Will Lead to a Major Uptick in IPO Profit Plays

BB&T said it plans to raise $1.5 billion by selling common stock, combine it with “other funds,” and repay all the capital from the U.S. Department of the Treasury’s Troubled Asset Relief Program (TARP).

The Winston-Salem, N.C. bank also said it will cut its divided 68% to 15 cents a share, an action that will save $725 million in capital a year. Chief Executive Officer Kelly King said the dividend reduction is temporary, and making the decision was marked “the worst day in my 37 year career.”

“However, we firmly believe this action is in the long-term best interests of our shareholders and our company because of the risk and uncertainty associated with being a TARP participant… When market conditions improve and our earnings provide for an increase in the dividend, we are committed to increasing it accordingly,” King said in a statement.

Capital One said it plans to raise about $1.75 billion by selling 56 common stock shares at $27.75 a piece. The bank expects net proceeds “to be used for general corporate purposes” and repaying the Treasury.

U.S. Bancorp plans to raise $2.5 billion by selling common stock to the public with the intention of repaying the Treasury with the proceeds. The Minneapolis-based bank also said it may offer medium-term notes in a benchmark amount in a public offering.

KeyCorp filed with regulators a plan to offer up to $750 million in common shares to raise capital.

Disdain for Government’s Eye

On Friday, the government’s stress test revealed that these banks are four of 10 that need to raise more capital if they were to survive a prolonged deterioration of the U.S. economy.

U.S. Bancorp borrowed $6.6 billion from TARP, Capital One took $3.55 and BB&T received $3.1 billion. In taking the billions in emergency loans, the banks also agreed to have tighter government control of their operations – including clamping down on executive pay.

The capital-raising plans – combined with the previously announced plans by Citigroup Inc. (NYSE: C), Morgan Stanley (NYSE: MS) Wells Fargo & Co. (NYSE: WFC) to pay back TARP money – show just how much these banks disdain working on the government’s dime and under the government’s eye. And it shows that they’re willing to further suppress their stock value and possibly upset their shareholders to break the government’s chains.

“Rational, objective lending is one of the most important purposes of the banking system, and when you inject Congress and the administration into it, it effectively politicizes the process, which is not healthy,” BB&T’s King told Reuters.

Source: BB&T, Capital One, U.S. Bancorp and KeyCorp Planning Stock Sales to Raise Capital, Repay TARP

Banks that require funding will have 30 days to present a capital-raising strategy to regulators and then six months to implement it.

It is unlikely that any of the banks will require any additional taxpayer money.

J.P. Morgan Chase & Co. (NYSE: JPM), Goldman Sachs Group Inc. (NYSE: GS), MetLife Inc. (NYSE: MET), American Express Co. (NYSE: AXP), Bank of New York Mellon Corp. (NYSE: BK), BB&T Corp. (NYSE: BBT), Capital One Financial Corp. (NYSE: COF), U.S. Bancorp (NYSE: USB), and State Street Corp. (NYSE: STT) are in the clear in terms of having adequate capital cushioning.

The following banks will be required to raise these assigned amounts of capital:

• Bank of America Corp. (NYSE: BAC): $34 billion.
• Wells Fargo & Co. (NYSE: WFC): $13.7 billion.
• GMAC LLC (NYSE: GMA): $11.5 billion.
• Citigroup Inc. (NYSE: C): $5.5 billion.
• Morgan Stanley (NYSE: MS): $1.8 billion.
• Fifth Third Bancorp (NASDAQ: FITB): $1.1 billion.
• KeyCorp (NYSE: KEY): $1.8 billion.
• PNC Financial Services (NYSE: PNC): $600 million.
• Regions Financial Corp. (NYSE: RF): $2.5 billion.
• SunTrust Banks Inc.( NYSE: STI): $2.2 billion.

The banks will have until June 8 to develop a plan to raise the required capital and until Nov. 9 to implement it. They may choose to raise the money in a variety of ways. They may sell assets, court private investment or convert the government’s existing preferred shares into common stock.

Citigroup has already announced plans to convert a portion of the government’s $45 billion stake into common stock, a move that will give the federal government a 36% stake in the company. Other regional banks – such as Fifth Third Bank or Regions Financial – could be forced to take similar actions, but are loath to do so, as most of the moves would be dilutive to existing shareholders.

Citigroup has agreed to sell Nikko Cordial Securities to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, is expected to boost the bank’s Tier-1 capital ratio by approximately 27 basis points.

Morgan Stanley plans to close its capital gap by selling assets or stock to private investors, a person briefed on the plan told The New York Times. And Wells Fargo said late yesterday that it plans to sell $6 billion in new common stock in an effort to raise required capital.

While Bank of America has said it doesn’t agree with the Fed’s conclusions, the bank yesterday outlined its strategy to accommodate the government’s demands. BofA is exploring the sale of such business units as its First Republic private-banking unit and asset manager Columbia Management, The Wall Street Journal reported.

The sale of those businesses could raise a combined $4 billion, David Hendler of CreditSights Inc. told The Journal. BofA could also get about $8 billion for its partial stake in China Construction Bank Corp.

Beyond that BofA would have the options of converting the government’s existing $45 billion investment, or $33 billion in private preferred shares, into common stock.

The Fed wants bank-holding companies to achieve a Tier 1 risk-based ratio of at least 6%, and a Tier 1 Common risk-based ratio of at least 4% by the end of 2010. The goal is to get banks to the point where they are stable enough that they can borrow from private investors without a Federal Deposit Insurance Corp. (FDIC) guarantee, people familiar with the matter told Bloomberg News.

“Going forward, we just need banks to be able to issue debt without the FDIC backing – that’s the next stage for these bank names in terms of evaluating their health,” Mark Bronzo, a money manager at Security Global Investors LLC, which oversees $21 billion in Irvington, N.Y., told Bloomberg.

If the banks fail to meet capital requirements, the government will step in to provide the necessary funds. However, it’s unlikely that any more taxpayer money will be needed, as about $110 billion of the original $700 billion in Troubled Asset Relief Program (TARP) funding remains.

Wall Street’s Reaction

The Dow Jones Industrial Average closed down 102.43 points, or 1.2%, yesterday, with the Dow Jones U.S. Financial Services Index down 3.78%. However, Wall Street’s reaction to the tests won’t be fully realized until the market opens later today (Friday).

“I think this will be a confidence-instilling announcement,” Federal Deposit Insurance Corp. Chairman Sheila Bair told a Senate panel Wednesday. “There will be additional needs for capital buffers for some institutions, but I think there will be mechanisms to do that within the next six months.”

Treasury Secretary Timothy F. Geithner said in an interview with PBS television’s “The Charlie Rose Show” that all of the institutions tested already have “significant cushions” of capital and that Americans have every reason to be confident going forward.

“The results will be, on balance, reassuring,” Geithner said.

But some analysts are skeptical about what the bank stress tests actually achieved, or if their standards of evaluation were even valid in the first place. After all, the tests have occupied resources from both the federal government and the private sector for months, and have increased stock market volatility.

“The banks are healing themselves, and it could have been done a lot faster if government had gotten out of the way instead of parking the emergency equipment in the middle of the road,” Gary B. Townsend, a former banking regulator who now runs his own investment firm, told The New York Times.

Also, many bank employees, and even Elizabeth Warren, who chairs the Congressional Oversight Panel for TARP, have expressed concern that the tests weren’t stringent enough.

Last month, Warren gave rise to speculation that another stress test might be needed by the end of the year, after she called the adverse economic scenario employed by the Fed “disturbingly close” to current economic conditions.

In the Fed’s most pessimistic economic forecast, for example, the government projects the unemployment rate will climb to 10.3% in 2010. But unemployment already hit 8.5% in March and many economists are predicting that it rose to 8.9% in April. If that’s the case, it’s not hard to imagine the national jobless rate reaching double digits by the end of the year.

“The stress tests will make a terrific contribution if they are tough and transparent,” Warren said. “If they are not, they will be useless.”

Still, despite the test’s alleged failings, there is a hope that with more transparency and a greater buffer of equity, investor confidence will be restored.

“This is sending a message that the banks need more capital, but their losses are manageable and the system itself is solvent,” Kevin Fitzsimmons, an analyst at Sandler O’Neill told The Times. “Whether it sticks is something else.”

Source: Bank Stress Tests: The Results Are in; Now What?

More from The Smart Profits Report:

When it comes to investing, the ability to play solid defense can ease you through turbulent times much better than most ordinary investors. And the concept here is simple: Defensive investing means having some strong, dividend-paying companies in your portfolio.

A 72-Year History Of Top Performance

The two main concepts that dominate the stock market climate are fear and greed. While they’re always prevalent, smarter investors know better than to base their decisions on fluctuating sentiments like these.

Instead, it’s better to look for long-term drivers – like earnings growth, cash, and the ability of companies to pay dividends to their shareholders.

History shows that the latter is a particularly smart way to go. From 1935 to 2007, more than 40% of the S&P 500’s total return came from reinvested dividends.

The beauty of dividend-yielding stocks is that they work well in both rising and falling markets. SensibleStocks.com reports that during the bull market of 1982 to 2000, dividend stocks actually outperformed non-dividend payers by a considerable margin, despite the underlying share price appreciation.

And in volatile, sinking markets like we’re experiencing now, it’s comforting to know that you’ve still got a source of income throughout the madness. You’re essentially being paid for your patience, rather than selling off like everyone else.

Let’s look at some more benefits…

Dish Me Some Dividends… Three Reasons To Invest In Dividend-Yielders

Lowers Cost: When you’re picking up a regular dividend payment per share every quarter, over time, it reduces the price you originally paid for the shares. It’s essentially like buying a house, then renting it out to offset the payment and pick up income, while the underlying asset appreciates at the same time. And of course, since the Jobs Growth and Tax Relief Reconciliation Act of 2003, investors have paid lower taxes on dividends.

Provides Stability During Downturns: When the broader stock market is under pressure and share prices are falling, stocks that pay dividends are often considered one of the “safer haven” investments, since investors are still receiving income. In turn, it’s good PR for a company, with the stock attracting more investors and the share price potentially rising as a result. Pay attention to the level of insider ownership of a stock here. This is not a hard and fast rule, but if insiders hold a big chunk of the company themselves, they’re less likely to be reckless with its money through overly ambitious projects or ill-advised buyouts, and may well pay greater attention to shareholder interests and dividends.

Keeps Management In Line: When an executive team is dishing money back to its shareholders, not only does it show sound business acumen to be able to do that in the first place, it also keeps them honest. Knowing that dividend payments must be met reduces the chances that they’ll fritter your money away on wasteful projects.

Of course, there are pitfalls, too. So before I get to a couple of investment options for you, let’s look at those…

Dividend Drawbacks

Dividend Reduction Or Suspension: At a time when obtaining credit is tighter than ever before, it’s much more likely that companies will reduce or suspend their dividend payments. This is usually a last resort, as it signals to the world that the company is having trouble raising cash, which can, in turn, severely impact its share price.

Twice The Tax… And Higher In 2010? Naturally, the IRS needs to grab its piece of the pie – and when it comes to dividends, it’s a double-whammy. First, it claims the regular corporation taxes from the company. Then, when the company passes what’s left down to its shareholders, those investors are then taxed on what they receive. In addition, the Jobs Growth and Tax Relief Reconciliation Act that I mentioned a moment ago expires in 2010, so we may see dividend taxes rise when it does.

Lack Of Investment Options: Some argue that while companies should be praised for rewarding shareholder loyalty through dividends, it may also mean that it can’t find other investment options, or projects that would accelerate the company’s growth.

And beware companies that offer sky-high dividend yields. It could merely be a crafty way to mask bigger problems. Automakers like General Motors (NYSE: GM) and Ford (NYSE: F) are good examples, as are some of the beaten-up financial stocks like Citigroup (NYSE: C).

And as share prices drop, dividend yields rise, which can be a false dawn. Bottom line: If a company isn’t growing its earnings or its cash-flow has shrunk, it may well be a bad sign. Make sure you do your regular due diligence.

Where To Look For The Best Dividends

Right now, two of the best dividend-yielding sectors are Consumer Staples and Telecom.

In the upcoming November Xcelerated Profits Report issue, my colleague Jim Stanton is recommending one of the best companies within the Consumer Staples sector, which pays a dividend. One of the advantages that this sector has during a downturn or recession is that it continues to generate revenue through essential repeat business. After all, consumers always need everyday household items.

(As an aside, you can get your hands on Jim’s specific Consumer Staples recommendation by signing up for the Xcelerated Profits Report. Just click this link for more details).

In the telecom sector, firms like Verizon (NYSE: VZ) and AT & T (NYSE: T) boast some rock-solid financials, allowing them to pay a 6.8% dividend ($1.84 per share annually) and 6.3% ($1.60 per share annually).

In the current climate, though, if you don’t want to take the chance on individual companies, you can always diversify and lower your risk by buying ETFs that hold dividend-yielding companies. Take a look at…

SPDR S&P Dividend ETF (AMEX:SDY): Holding stocks like Bank of America (NYSE: BAC), Pfizer (NYSE: PFE), Fifth Third Bancorp (Nasdaq: FITB) and Consolidated Edison Inc (NYSE: ED), the fund tracks the price and yield performance of stocks in the S&P High Dividend Aristocrats index.

PowerShares High Yield Dividend Achievers (AMEX: PEY): This fund’s results try to correspond to the Dividend Achievers 50 Index. Around 80% of its holdings are in companies that have consistently raised their dividends. Its holdings include Bank of America, Keycorp (NYSE: KEY), American Capital Strategies (Nasdaq: ACAS), BB&T Corp (NYSE: BBT) and Comerica (NYSE: CMA).

Source: These Dividend Stocks Keep On Giving… Even As The Market Keeps Falling

The rally was sparked by commitments from the major financial nations to cooperate in getting the credit markets functioning again, and by news that U.S. officials were putting the finishing touches on Washington’s version of a rescue plan under which the U.S. Treasury Department will invest an estimated $125 billion in nine major U.S. banks, and another $125 billion in smaller financial institutions, Bloomberg News reported early this morning (Tuesday).

The White House announced that U.S. President George W. Bush would meet at 7:30 a.m. EDT today with members of his financial markets working group. He’ll make a statement about the plan at 8:05 a.m. U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., U.S. Federal Reserve Chief Ben S. Bernanke and Federal Deposit Insurance Corp. Chair Sheila C. Bair will discuss the plan during an 8:30 a.m. news conference, MarketWatch.com and Bloomberg both reported.

“These are tough times for our economies, yet we can be confident that we can work our way through these challenges and America will continue to work closely with the other nations to coordinate our response to this global financial crisis,” President Bush told reporters yesterday following a meeting with Italy Prime Minister Silvio Berlusconi at the White House.

After an eight-day losing streak – the worst for the Standard & Poor’s 500 Index since 1996 – those dramatic worldwide developments were enough to spawn a rally of historic proportions in U.S. shares. The S&P 500 rebounded from its worst week in 75 years with an 11.6% advance, jumping 104.13 points to close at 1,003.35. The Dow zoomed 936.42 points, or 11%, to close at 9,387.61 – eviscerating the previous record of 499 points, set in March 2000, and posting its best percentage gain since 1933.

The Nasdaq Composite Index climbed 194.74, or 12%, to 1,844.25. Sixteen stocks gained for each that fell on the New York Stock Exchange.

Last week’s 18% declines pushed both the S&P 500 and Dow down more than 40% from their peaks last October.

The S&P 500 ended the trading day Friday at 17 times reported earnings of its companies, the cheapest valuation in more than a year. Yesterday’s really boosted the Price/Earnings ratio to 19.2. The S&P 500 is still down 32% this year, positioning it for its worst yearly loss since 1937.

“The worst of the immediate danger is past,” Bruce McCain, chief investment strategist at Key Private Bank (KEY) in Cleveland, which manages $30 billion, told Bloomberg, the well-known financial news service.“It’s always easier when you’ve got markets going up and you’re not having to talk clients back in off the ledge.”

Kevin Divney, chief investment officer at Putnam Investments in Boston, told Bloomberg Television that “the real catalyst is the levels of valuation.”

But not everyone was quite so sanguine. Money Morning Investment Director Keith Fitz-Gerald cautioned that one strong day in the markets – even a record one – doesn’t necessarily mean there’s a full-fledged rebound in store.

“The real economic growth rates in the financial sector are unclear,” Fitz-Gerald said in an interview. “To say that it’s an accounting nightmare is an insult to the Hollywood honchos who actually make their living transforming nightmares into movies. Fiction writers could not concocted a better horror story than the one that’s rocked world financial markets since last November. Despite all the mergers and acquisitions, and the emergency bailouts, that we’ve seen to date, Wall Street hasn’t even begun to address the underlying business prospects – on anything more than a superficial level – of the lion’s share of the companies that are being bailed out.” [For Fitz-Gerald’s full take on yesterday’s market action – including some insights on how he believes investors should navigate the uncertainty – check out his special market commentary that appears elsewhere in today’s issue.]

All 10 industries in the S&P 500 added more than 7%. Monday’s worldwide rally – which ranged from Tokyo to New York – sent the MSCI World Index up 9.5 %, the biggest gain since the gauge was created in 1970, MarketWatch reported.

The bond market was closed for the Columbus Day holiday. The dollar fell the most in three weeks against the euro.

Details of a Bailout/“Rescue” Plan

On Sunday, the major European Union nations committed more than $2.3 trillion to safeguard their banks and financial system, according to The Associated Press.  Global efforts to rescue the international banking system gathered force yesterday, with Europe leading the way to provide money to shore up its financial sector and calm traders, and the U.S. hinting it’s on board with its own rescue plan, MarketWatch reported. [For details of the sweeping European rescue plan, check out this related report elsewhere in today’s issue of Money Morning.]

U.S. bankers were summoned to the Treasury Department yesterday, as the U.S. government prepared additional measures to stabilize markets, reported the U.S. shortwave broadcasting service, The Voice of America.

Over the weekend, Treasury Secretary Paulson had called the heads of the five biggest U.S. banks to come to Washington for face-to-face talks about the rescue plan, according to people briefed on the matter. Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, Morgan Stanley (MS) CEO John J. Mack, Citigroup Inc. (C) CEO Vikram Pandit, JPMorgan Chase & Co. (JPM) CEO Jamie Dimon and Bank of America Corp. (BAC) CEO Kenneth D. Lewis were all asked to attend, according to The AP.

The CEOs had been in Washington this past weekend to meet with international finance officials at the annual meetings of the International Monetary Fund (IMF) and World Bank. This group of U.S. banking sector leaders met with Paulson and Fed Chairman Bernanke for about three hours yesterday, several news sources have said.

When asked for precise details about the plan that’s to be unveiled early today, U.S. Treasury officials remained mum. Indeed, sources would only say that it would include a “series of comprehensive actions to strengthen public confidence in our financial institutions and restore functioning of our credit markets.”

However, after the CEO meetings, some details began to leak out. Industry insiders speculated late yesterday that the Federal Reserve and Treasury Department had outlined a plan to inject as much as $250 billion of the $700 billion rescue plan into top U.S. banks.

In addition, to jumpstart “Interbank” lending, the FDIC would actually insure new senior preferred debt for three years.

The Treasury Department would take the equity stakes in banks using authority it was granted under the $700 billion bank rescue plan enacted two weeks ago.

“We’re talking about making investments in these banks in a way that doesn’t necessarily punish existing shareholders,” Charles Bobrinskoy, vice chairman of Ariel Investments LLC, which manages $13 billion, said on Bloomberg TV. “Most of the bank actions to date in the U.S. have been good for bondholders but terrible for common stockholders.”

Government actions this year to prevent bankruptcies at investment bank Bear Stearns Cos., mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE) and insurer American International Group Inc. (AIG) resulted in near-total losses for the firms’ shareholders.

The collapse of New York-based Lehman Brothers Holdings Inc. (LEHMQ) on Sept. 15 precipitated the latest chapter of the 14-month-old credit crisis, causing banks to stop lending to each other out of concern they may not get their money back.

Direct investments of this magnitude represent a new approach for Treasury Secretary Paulson, who initially advocated a bailout targeted at illiquid mortgage-related assets. When the markets didn’t respond positively to earlier plans, the Treasury Department shifted gears – in a big way.

“They’ve decided they need to do something drastic and this is drastic,” Gerard S. Cassidy, a bank analyst at RBC Capital Markets (RY) in Portland, Maine, told Bloomberg.

The proposed cash injections in exchange for preferred shares are said to be destined for Citigroup, Goldman Sachs, Wells Fargo & Co. (WFC), JP Morgan Chase & Co., Bank of America Corp., Merrill Lynch & Co. Inc. (MER), Morgan Stanley, State Street Corp. (STT), and Bank of New York Mellon Corp. (BK).

“The government has gone to ‘Plan B’ and it packs a big wallop,” Frederic Dickson who helps oversee $25 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon, told the financial news service.

The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.

The government will obtain its stakes with a type of security designed not to dilute the value of common shares.

None of the nine banks getting government money was given a choice about it, said people familiar with the plans. All of the banks involved will have to submit to compensation restrictions as mandated by Congress, people said.

The remaining $125 billion will be used to recapitalize other financial institutions around the country, the people said. Neel Kashkari, the U.S. Treasury official overseeing the rescue of the financial system, yesterday said the equity purchases would be aimed at “healthy” firms.

Source: Dow Zooms to Record Gain Yesterday on Reports The Government Will Reveal Banking Bailout Plan Details Early Today

Right there in big capital letters was the advice to buy banks, with the caveat that you should do it selectively.

And no, as it turns out, I wasn’t dreaming.

The article argues that valuations are low and the companies still have significant earnings power.

Last week’s sharp rally in the financials gave investors some hope that the banks were done cratering. And many took Wells Fargo’s (NYSE: WFC) strong earnings report as a sign that we’ve seen the worst in the sector.

…But The Worst Isn’t Over Within Financial Investments

The way I see it, this magazine cover reinforces the idea that the bottom is nowhere in sight.

Now I’m not a conspiracy theorist, despite my belief that the 1985 NBA draft was rigged so that the Knicks would-thankfully-get Patrick Ewing. Nor am I a Chicken Little, as I believe any of my regular readers can attest to.

But while I’m not about to say the sky is falling, I do believe bank stocks will for a while.

This is not a stance I take lightly, especially considering that Mt. Vernon Research Investment Director Karim Rahemtulla, is well-schooled in picking and choosing from the financial sector. In fact, using his deep in the money covered call strategy, he has actually racked up gains on companies like JP Morgan, Wells Fargo, and US Bancorp.

(If you are going to get involved in financial investments, you really should only pick the stocks and strategies that Karim recommends in Xcelerated Profits Report.)

If anyone can pick winning stocks in a losing sector, it’s Karim.

But you have to look at it this way: if some of these banks needed to raise money and were offering bonds at a competitive rate, would you help finance them?

Would you buy a Lehman Brothers (NYSE: LEH) bond maturing in 2017 with a yield of 6.3%? I sure wouldn’t.

How about a Fifth Third Bancorp (Nasdaq: FITB) 4.9% yield maturing in 2018? Thanks but no thanks.

A Key Corp. (NYSE: KEY) bond maturing in 2014 paying 5.6%? Ummm…No, I think I’ll pass.

If I’m not certain that a bond will be paid back, why would I want to own the stock? After all, the bond owners get paid before the stock owners.

It’s my contention some of the banks and brokers don’t even know what they own on their balance sheets. The mortgage products and derivatives were so complex that the average CEO can’t explain them.

And these guys aren’t dumb. They may have made some poor decisions, but stupid they ain’t.

We may get a lift for a while, but there’s going to be a lot more pain in the sector as companies are forced to continue write downs when they realize the value (or lack thereof) of the garbage on their balance sheets.

Zig When They Say Zag

Furthermore, the magazine cover indicator has been a fairly reliable predictor of stock movements. It was even proven by academics at the University of Richmond.

The professors examined headlines from three major business publications over twenty years and compared the stock performance to the bias in the headline.

The study concluded that positive stories were typically published after periods of strong out-performance and negative stories after underperformance. In other words, these stocks had already made their strong moves.

As their share prices declined, their dividend yields went in the opposite direction. That undoubtedly attracted investors who thought such high dividends would put a floor under how much share prices could drop. In the meantime, these investors could just sit tight and collect dividend checks earning them six, seven, or eight percent interest on their investment.

But it hasn’t turned out that way. Both the floor and yields proved ephemeral. Guess which of the companies in the one-month chart below have cut their dividends?

KeyCorp (KEY) (the dark green line) – 50 percent down in the last month – is one. Citibank (C) (the brown line) – 10 percent down – is another. Washington Mutual (WM) (the pink line) –35 percent down – is a third. And Fifth Third Bancorp (FITB) (the red line) – 50 down – is a fourth.

And all the others in the chart are on the chopping block for future possible cuts. Well, all except the Bank of Nova Scotia. The shares of this Canadian bank aren’t doing great, but it’s doing much better than most U.S. banks.

If you’re waiting for banks to bottom, you’re playing a dangerous game. Many are raising capital in expectation of future write-offs. The rapid rise of foreclosures is increasing banks’ bad debt. And, whenever the market falls precipitously, it’s usually led by financials. Banks are leading the market down … not showing it the way up.

If the worst is really behind banks (I can’t tell you how many times I’ve heard that), what’s coming up is pretty damn close. If I were you, I’d stay away.

Source: False Hope and False Bottoms Still Define Banks

National City was forced to take a $333 million fourth quarter loss due to an ill-timed push into the residential mortgage market with a heavy emphasis on subprime loans. The Cincinnati-based bank also recently expanded its retail branch network into Florida, an area that has been hit particularly hard by the slowdown in the real estate market.

Cleveland-based Fifth Third is the 12th-largest U.S. bank with $110 billion in assets. The two banks key market areas overlap and a merger could potentially offer a sizeable cost advantage.

KeyCorp (KEY), another Cleveland-based bank with about $100 billion in assets is also considering an offer for National City, with the backing of private equity firm Kohlberg Kravis Roberts & Co.

But KeyCorp has a sizeable portion of its business in the Northwest and Rocky Mountain region, potentially making it a less than perfect fit for a merger with National City. A Fifth Third/National City merger would prove a formidable rival.

“Both of those companies because of the overlap with National City would be able to cut costs,” Terry McEvoy, an analyst at Oppenheimer & Co. (OPY) told Reuters, referring to KeyCorp and Fifth Third. “Cutting costs would support a higher price should the one option National City decides be to sell out.”

Any potential merger would be complicated and a deal has yet to be reached.

“While we never comment on potential mergers, we have consistently said that we are focused on strategic opportunities for in-market consolidation,” a Fifth Third representative said, The Wall Street Journal reported.

National City declined to comment, other than to say the bank was investigating options with the help of hired advisor, Goldman Sachs Group Inc. (GS).