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Foreclosure mess to test stocks’ rally

Investors will pepper bank executives with questions when those companies present earnings reports this week. Banks reporting results include Wells Fargo (WFC.N), Bank of America, and Citigroup Inc (C.N), three of the largest mortgage lenders in the nation.

A foreclosed home is seen in Bullhead CityThe broad S&P financial sector is expected to show earnings of $27.7 billion in the third quarter, a 71 percent increase over a year earlier, although third-quarter revenue growth is seen falling 6 percent to $252.9 billion.

However, earnings estimates have been cut on some banks. Financials with the biggest reductions in earnings estimates for the quarter in the latest week are Goldman Sachs (GS.N), PNC Financial (PNC.N), and Citigroup, according to John Butters, director of U.S. earnings at Thomson Reuters.

The financial sector has been a conundrum in the latest market rally since the start of September. The KBW index (.BKX)has gained only 4 percent at a time when the broader S&P 500 has rallied nearly 12 percent.

David Giroux, who runs T. Rowe Price’s $9.4 billion Capital Appreciation Fund, said expectations that deflation would weigh on bank earnings in the near term was pressuring the sector. He said banks were now attractively valued and the sector is the fund’s largest, making up nearly 15 percent of assets.

“Most of the large banks are asset sensitive, which means that as rates rise, their profits should rise,” he said. “So if you’re a big believer in deflation, which the market has become a big believer in … financials do poorly.”

Giroux said a second round of stimulus from the Federal Reserve was unnecessary as inflation was already present in the system. Hopes the Fed will pump billions into the economy have helped drive stocks higher recently.

The Fed will release its Beige Book during the week and that will provide another insight into the central bank’s thinking on the economy. On Friday, Fed Chairman Ben Bernanke hinted more monetary stimulus was on the way.

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