The Golden Age for Financial Stocks

In December 2011, I changed my mind on the financial sector and said that it was finally a good buy. At the time, the Financial Sector ETF (XLF) was at $12.82 per share and today it’s been as high as $19.60. That’s a nice 52% run.

Actually, that call wasn’t completely out of the blue. Three months before, I said that the XLF would be a good speculative buy if it fell below $12. I wasn’t ready to say the sector was a flat out buy. The XLF did fall below $12. In fact, it briefly dropped below $11. As usual, market trends can last longer than you thought possible.

In the CWS Market Review from two months ago, I said that we’re in a Golden Age for investing in financial stocks.

Let’s run down some of the reasons why the financial sector is so appealing. The biggest is that the Federal Reserve is keeping short-term interest rates near 0% and has promised to keep them there for some time. The Fed’s position clears up a lot of uncertainty, and Wall Street likes it that way. Another big reason in favor of financials is that the economy is slowly improving. At a firm like Nicholas Financial, the overall quality of their loan portfolio has improved dramatically.

We also have to look at the mortgage market. For obvious reasons, many financial stocks are closely tied to the mortgage market, and the U.S. housing sector continues to improve. Thanks to Bernanke and his friends at the Fed, the bond-buying policy has pushed down mortgage rates and they’ll probably stay low. This time, the improvement in the housing market is far sounder and more sustainable than it was last decade. Let’s not forget that lending standards have thankfully improved.

Another key point is that valuations for many financial stocks are still quite modest. JPM just broke though $50 per share and it’s going for less than nine times Wall Street’s estimate for next year’s earnings. Based on Thursday’s close, JPM yields 2.4% and I’m expecting the bank to raise its dividend soon. I think the current 25-cent quarterly dividend will go up to 30 cents per share. That would still be less than 22% of their full-year earnings.

Given the current environment, I doubt many investors will be able to beat XLF this year or do it with less volatility. We’re going to look back at this era as a great time to buy financial stocks.

I turned out to be right about JPM’s dividend. Less than a week later, the bank raised its dividend to 30 cents per share.

Posted by Eddy Elfenbein on May 14th, 2013 at 1:06 pm

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.