Lesson of the year #10 - Financials = Long-term

by Jay Pestrichelli on December 16th, 2011

We’d like to round out this crazy year with what we think were some of the most impactful lessons that the individual investor had to deal with in 2011. Over the next few weeks we’ll lay out what we’ve learned and maybe even include some things to watch out for in 2012.

#10-The Financials have truly become a long-term investment.
The financials struggled this year, to say the least. As one of the worst performing sectors of 2011, the intention of the FED to keep interest rates low will continue to apply pressure to the income stream of the banks. See this chart of the XLF, down 18% in last 12 months.
In case you’re not aware of why, it’s a matter of simple math. Banks borrow at one rate and lend at another. The way they make money is to lend at a rate higher than what they pay on borrowed funds. The money they make from the difference in rates is called Net Interest Income (NII).

When interest rates are lower, there is less NII to go around. We’ve seen the banks this year try to find other sources of income with debit card charges and even charging larger accounts an interest rate to hold assets vs. paying out interest. To say the least, they’ve been unpopular and have cut into satisfaction, an important part of the client relationship.

All of this illustrates why there is less revenue for the banks in this kind of interest rate environment. And the banks know this as well. We’ve seen almost all the major banks go through some level of layoffs. Morgan Stanley is the latest, but we’ve also heard from Citigroup, Bank of America, UBS, Barclays and Goldman Sachs about some level of a reduction in force, albeit, with different size cuts.

If you’ve had the banks in your portfolio, you’ve been stuck waiting for the rebound. We’re on the look out for it as well, but it doesn’t look like it’s coming anytime soon. Lets face it, there are some great franchises out there and no full market recovery can happen without the financials participating. But with the outlook for interest rates staying low through mid 2031 expect those banks to continue their uphill battle.


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