While we are still long JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC), within client accounts, we sold our Goldman Sachs (NYSE:GS) holdings in January ’14 at roughly $171 – $172 as well as our Financial Select Sector SPDR Fund (ARCA:XLF) (Financial ETF) and reduced our weighting in Financials as we came into 2014.
Financials is one of the largest sectors in the S&P 500, second only to Technology at 16% – 17% of the S&P 500′s total market cap weighting. Technology’s weighting in the S&P 500 is roughly 18% – 19%, perhaps a bit lower today given the correction in the Nasdaq.
One of our best sector calls for 2013 was starting to pound the table on Financials, as far back as September, 2012 here, November, 2012 here, and January, 2013 here.
The tipoff to Financial’s outperformance in 2013 began in the fall of 2012, as forward earnings estimates for the sector remained stable or were even revised slightly higher, as S&P 500 earnings were being slowly reduced.
Here is the projected and actual earnings and revenue growth for Financials the last few years:
- Q4 ’14: +11.4% (est)
- Q3 ’14: +23% (est, but comp quite high given JPM Morgan charge in Q3 ’13, which wiped out over $1 in JPM’s EPS)
- Q2 ’14: +1.0% (est)
- Q1 ’14: 0%, -0.7% (est, big banks have reported thus far, as well as brokers)
- Q4 ’13: +24.7%, +0.2% rev gro
- Q3 ’13: +1.5%, +6.2% rev gro (includes that massive JPM charge referenced above)
- Q2 ’13: +30%, 4% rev gro
- Q1 ’13: +18.2%, +20.7% rev gro
- q4 ’12: +17.4%
One of the big contributors to Financial earnings growth in 2013 was loan loss reserve releases (or LLRs), which have now stopped and in fact, banks are now adding or building credit reserves once again, rather than releasing reserves, which are accretive to EPS.
A lot of banks are valued on “pre-tax, pre-provision” (PTPP) profitability, but I do suspect that Street analysts are now building reserves for 2014 and beyond, which has reduced sector earnings growth.
The flip side of this argument is that if banks can ever grow revenues again, it would offset some of the credit additions now going on in banks.
We have sold out of our GS, and never really owned Morgan Stanley (NYSE:MS), although we think that Morgan Stanley’s strategy of emphasizing the asset management business over the more volatile sales and trading businesses is the right move given the regulatory environment.
We think the former discount brokers which are now asset gatherers like Schwab (NYSE:SCHW), Ameritrade (AMTD.K) and the exchanges are going to be the secular growth financials.
My point of view: the exchanges like ICE, CME and CBOE as well as NDAQ will benefit from volume growth, and less regulatory oversight over the next few years. CME is our largest holding currently. We are awaiting lower levels on CBOE and ICE.
If the 2-Year Presidential Cycle analog for 2014 gains traction, (we wrote about it here) it could mean a tougher year for Financials through Q4 ’14. We do expect a Q4 ’14 rally into year-end.
There is no question Financial sector earnings growth will be lower this year than they were in 2013.