How Will Banks Fare in the Bailout?

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GM May Be a Loser

Other losers may include companies such as General Motors (GM), whose affiliated financing arm GMAC likely has exposure to toxic securities but may not qualify for the government bailout because it's not strictly a financial firm, says Ablin. "You certainly get into odd territory with GMAC," he says. "It's almost entirely owned by a private equity fund [Cerberus Capital Management]. So do you want to bail out [Cerberus chairman] John Snow?"

Commercial banks, most of which have kept their balance sheets free of toxic assets, will probably benefit indirectly as the increase in market liquidity will help push their borrowing costs lower, says John Jay, senior analyst at the Aite Group, an independent financial services research firm in Boston. "If [its funding costs] go low enough, their senior managers will start to look for businesses to lend money to." In the end, their profit margins are expected to grow as the differential between their borrowing costs and lending rates widens.

The shares of some financial players have had a strong run in spite of the market's attempts to paint them with the same brush as the rest of the industry, says Jocelyn Drake, an equity analyst at Schaeffer's Investment Research in Cleveland. PNC Financial Services (PNC), Wells Fargo (WFC), and Hudson City Bancorp (HCBK) all steered clear of toxic assets and their shares hit one-year highs last week before Treasury Secretary Henry Paulson announced the plan on Sept. 18. The shares posted further gains after the announcement.

Skeletons in the Closet

Schaeffer's tends to base its stock picks on technical performance and the degree of pessimism directed at them. Market pessimism —which is reflected in analysts' ratings, the level of short interest and the ratio of options betting on lower prices for certain stocks vs. bets on higher prices—can give you a sense of how much investing money is sitting on the sidelines waiting for the right signals to come into the market. "There are still some skeletons that could come out of the closet [for the financial industry] and hinder the group," says Drake. But she's betting that as certain stocks continue to buck the trend and outperform their peers, sidelined investors will cave in and start to buy these stocks so as not to miss the boat.

There are also a couple of homebuilder stocks that Drake expects to benefit as liquidity returns to the housing market and inventory begins to move.

She likes Meritage Homes (MTH) and Toll Brothers (TOL), both of which have been in an uptrend since the beginning of this year. She takes the drop in mortgage rates after the government bailout of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) was announced two weeks ago as a positive sign, which she believes will help stoke demand for houses.

A Contrarian View

She recommends that investors hedge such bets that go contrary to market sentiment by buying shares of index exchange-traded funds that short the corresponding sectors. For financials, she uses Financial Select Sector SPDR (XLF and UltraShort Financials ProShares (SKF) to hedge her bank picks and SPDR S&P Homebuilders (XHB) to protect against the downside in homebuilders.

Bogoslaw is a reporter for BusinessWeek's Investing channel.