We like Financials as a sector - but do we like any stocks in that sector?

by Wayne Ferbert on March 8th, 2012

You might have seen our blog post last week (check it out here) in which we added Financials to our ‘sectors we like’ list. The list is short and focused: Financials, Technology, & Energy. Tech and Energy were on our list for all of 2011 – and financials is the new addition. You might remember that we removed consumer staples from the list.

Typically, in our sector rotation approach, we mostly use ETFs – and we like the SPDR Sector Select ETFs. So, to get Financials exposure, you can use the ETF with the symbol XLF. It will provide you with diversity across many large cap financials.

But if you like to use individual stocks, let’s revisit some of the stocks in this space that we have talked about before. And remember, when you use individual stocks in your portfolio it is CRITICAL to hedge your investments. Individual companies carry a lot more risk than a diversified ETF.

Banks

We have talked about Bank of America before (BAC) and as full disclosure, both the author and his clients have bullish positions in BAC. The run up to $8 has been nice – but we bought BAC with a 2-3 year horizon in mind. We believe this stock has more intrinsic value than the current stock price reflects. If you remember our investment thesis was that it has three fantastic franchises: Merrill Lynch brokerage, Investment Bank, and Retail/Commercial bank.

BAC’s stock price has started to consolidate around the $8 price. The last 30 days it has really just been moving around that mark – despite spending the 2nd half of 2011 bouncing around like a piñata. I like this recent trend. The $8 looks like resistance – but we know that resistance often turns in to support later. I think the buyers have started to come in to this stock – and they have been consolidating up to the $8 price. I think many of these new owners are long term holders. If the financial system can avoid any unforeseen shocks, then I like BAC to move up from $8 in 2012 and in to 2013.

Brokers

Having spent a decade in the online brokerage business, you know I am going to be partial to the e-brokers. What the average investor doesn’t know is that their online brokerage makes most of his money from the idle cash left in the client’s account – not from the commissions the broker charges. The broker re-invests the cash at higher yields than they pay to the investor to maintain that cash position.

It has been a great money maker for the better part of a decade – until interest rate reductions crashed that party. Now, the brokers have had to pull back and perform layoffs and bunker down on costs. The stock prices all reflect it. But lately, there has been a little life in the stocks – but they are still under-performing the broader financial sector and the S&P 500.

When interest rates return to normal, expect these firms to obviously benefit from an improved interest rate spread. These firms are a great example of financial firms that are completely tied to interest rates for their earnings. You could even say they are a ‘levered’ play on interest rates since 99.9% of every dollar of improvement from the spreads will go straight to the bottom line for these firms.

The two best publicly traded companies in this space are TD Ameritrade (AMTD) and Schwab (SCHW). Both have excellent management teams and both have built a very sticky client base. Both have also not even come close to recovering to their 2007 stock levels. Of course, because of interest rates, neither is near their 2007 earnings either.

If you have a long-term view and expect interest rates to improve by 2013 AND want to be ahead of the curve on the interest rate news, consider these two brokerage stocks. (Full disclosure: The author spent a decade working at TD Ameritrade and is partial to their excellent management team, of course. The author has clients with bullish positions in both SCHW and AMTD).

Asset Managers

In an upcoming blog post, we’ll look at asset managers. I haven’t had enough time to put them all under the microscope like I’d like to – but the 5 we plan to look closely at are: Franklin (BEN), Invesco (IVZ), T Rowe Price (TROW), Janus (JNS), and Blackrock (BLK). Stay tuned for future analysis on these players. Some of them are also dependent on interest rates more than others (like BEN). They all grow earnings if the markets grow more because they get paid based on AUM. We’ll come out with more on them soon!


Posted in not categorized    Tagged with no tags


2 Comments

Rick - March 12th, 2012 at 12:40 PM
I would guess the possibility of increased interest rates in the next 1 to 3 years is excellent. The government debt is exploding and money supply is increasing faster than the GDP is growing. This will probably cause inflation to hit us soon!
Jay Pestrichelli - March 12th, 2012 at 3:50 PM
A thoughtful comment and if true, would help the financials greatly. The flip side to the debt argument is that if interest rates rise, the US will have to pay out higher dollars on these elevated debt levels. Which in turn, put a drag on the US’s ability to pay it off. Just food for thought…

Leave a Comment