The Financial sector has been an overweight for some time in client accounts and it has hurt performance since January 1, ’18.
Client’s biggest financial weighting has been Schwab (NYSE:SCHW), given its asset-gathering prowess (and it is our only third-party client custodian) and then JPMorgan (NYSE:JPM), Chicago Merc (NASDAQ:CME), the XLF (big bank ETF) and unfortunately the KRE (regional bank ETF).
Bill Nygren, the famed OakMark Fund Value manager, had this to say to Christine Benz in a Morningstar podcast where Bill and the OakMark Select Fund was seeing value today:
At the other extreme, the banks have rarely sold at less than half the S&P multiple where they’re at today. They sell, a lot of them, around tangible book value, single-digit P/Es, yet, are much better businesses than they have been for the past decade or so–better lending standards, higher capital ratios, more of a competitive advantage from technology. That ratio of bank stocks to electric utilities to pay half as much on a multiple basis for banks as you would for an electric utility I think is an incredible value.
It’s not like we think that loan growth is suddenly going to skyrocket to double-digit levels. A bank like Bank of America (NYSE:BAC) was just given approval to buy back 11% of their stock over the next year, and they’re not digging into capital to do that. That’s just the capital that they will be generating over the next year, and that’s in addition to a dividend yield of about 3%, which is about all you’re getting on electric utilities, anyway.
So, I think the opportunity for a long-term investor to create a portfolio today of dramatically undervalued names and to void some sectors that look pretty fully valued should create an opportunity to meaningfully outperform the rest of the stock market. We don’t think the rest of the stock market is overvalued.
Nick Colas and Jessica Rabe on their newly launched blog, “DataTrek Morning Briefing,” wrote last night that:
#2: While US banks have fared much better than their European counterparts over the years, recent worries over structurally low/declining interest rates have taken a real toll on their stocks:
The S&P Bank Index, an even-weight measure of 90 public equities, is down 17% over the last year in price terms (i.e. near bear market territory). Six points (35%) of that decline have happened in just the last month.
Valuations for the largest US banks are very low, at 9-12x expected earnings versus 17.5x on the S&P 500: JP Morgan (10.4x forward earnings, 3.0% dividend yield), Bank of America (NYSE:BAC) (9.0x, 2.7% yield), Wells Fargo (NYSE:WFC) (9.8X, 4.6% yield), Citigroup (NYSE:C) (7.5x, 3.2% yield), and US Bancorp (NYSE:USB) (11.8x, 2.8% yield).
Nick was writing about the European bank stock chart, which many think does not look good. So will US banks be a safe haven for those looking for global financial exposure or will they get dragged down by Europe's bank mess. (Frankly, I have no opinion on that.)
According to this chart, the XLF and KRE have under-performed the S&P 500 for the last 10 years.
CME has been a decent performer, as has ICE (NYSE:ICE). Both have made all-time-highs with the S&P 500.
It’s tough to sell the KRE here, even with the yield curve in this kind of shape. In investing, everything changes (eventually).
Conclusion
What worries me is that i was studying money and banking in 1980 when Paul Volcker was moving the fed funds rate around like a matador waves a cape at a bull and Fed Funds reached 20% during the time I was studying monetary policy from a Cincinnati Fed professor. Now, like the money supply in the late 1980s, I worry that monetary policy is becoming completely irrelevant, in that its effect on the US economy seems to be diminishing over time. Housing fell flat in late ’18 after the FOMC raised rates – 9 times – between December ’15 and December ’18 but otherwise the economy never really blinked. Is that because of generational low interest rates ?
To think that the Fed is cutting rates again after the fed funds rose to only 2.5% and we’re on the way back down, makes me want to yell into the Chicago night “Are you bleeping kidding me ?”
After 2008, the inevitable disintermediation of the traditional banks began when the Obama Administration put the “Dirty, Rotten Scoundrel”-like cuff around the banking system and forced banks to raise capital and reduce leverage after the worst consumer recession since the the Great Depression. All that did was force private companies to start lending and taking credit opportunities away from the traditional financial intermediaries.
It is puzzling why, with such a strong consumer and housing credit market and such low loss delinquencies, the banks can’t respond better to strong earnings growth.
The Financial sector has the 3rd best earnings growth of any S&P 500 sector for Q2 ’19:
What may be even more remarkable is that Financial’s “expected” +4.7% for Q3 ’19 expected earnings is the highest rate of earnings growth of the 11 sectors.
Thanks for reading.