Oct. 15 (Bloomberg) -- Richard Bernstein, the former chief investment strategist at Bank of America Corp. who recommended selling banks in March, says investors should own them now.

“People like me have underestimated the rebound,” said Bernstein, chief executive officer of New York-based Richard Bernstein Capital Management LLC. He became more optimistic on banks around the middle of the year and says investors who hold financial shares shouldn’t sell them because “the government has basically said it’s not going to allow any big shoes to drop.”

The 79 banks, insurers and investment firms in the Standard & Poor’s 500 Index have rallied 157 percent since March 6 on speculation that the worst of the credit crisis is over. Banks had plunged 84 percent from a record in 2007 as the collapse of the subprime mortgage market led to more than $1.6 trillion in losses and writedowns, froze credit markets and sparked the first global recession since World War II.

Those who stuck with Bernstein’s March 23 missed about half of the rally in financial shares. They still made money from his advice in August 2008 that investors were “significantly underestimating” the extent of the credit crisis. The next month, he said the U.S. government’s plan to move troubled assets from the balance sheets of American financial companies didn’t change his bearish outlook for shares in the industry.

Founded Own Firm

Bernstein, 50, left Charlotte, North Carolina-based Bank of America in April to start his own money-management company.

The S&P 500 Financials Index surged 3.4 percent yesterday, the most among 10 industries, after JPMorgan Chase & Co. beat the average analyst earnings estimate by 61 percent because of surging fixed-income revenue. JPMorgan, based in New York, is the second-largest U.S. bank by assets.

JPMorgan was the first of the largest U.S. banks to report third-quarter results. Goldman Sachs Group Inc. reported third- quarter earnings that fell short of the bank’s record today. Citigroup Inc., the lender 34 percent owned by the U.S. government, posted a $101 million profit, defying expectations for a loss, as the company added the smallest amount to loan- loss reserves in two years.

Bernstein said financial companies will report “good earnings, but not great earnings given the spotlight they’re under in terms of compensation” and the need to “repay the taxpayer.”

$8.79 Billion in Pay

JPMorgan set aside $8.79 billion for compensation this year, or 38 percent of revenue. That’s up from $6.54 billion in the same period of last year, when the unit allocated 52 percent of revenue to pay employees. The bank repaid $25 billion of U.S. rescue funds in June even as credit-card and mortgage losses continued to mount. Credit costs will stay high “for the foreseeable future,” Chief Executive Officer Jamie Dimon said yesterday.

Bernstein said he’s still concerned about the fallout from the financial crisis.

“The number of small banks failing is rising very dramatically,” a trend that will probably last several years, he said. “We still need significant consolidation in the financial sector to make the long-term growth prospects for the sector look favorable.”

Regulators have closed 98 banks this year, the most since the savings-and-loan crisis of the early 1990s, as lenders struggle with mounting losses on real-estate loans.

The performance of the stock market hinges on the job market, Bernstein said. The number of Americans filing first- time claims for unemployment benefits dropped last week to the lowest level in nine months, indicating the improving economy is leading to a slowdown in firings, Labor Department data showed today.

“If the employment figures erode, then I think we’ll have a correction as everybody is waiting for,” he said. Should jobless claims continue to decrease, then “the odds of a correction will be relatively small,” he added.

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net.

Last Updated: October 15, 2009 21:10 EDT