Financials Ease Back in the Limelight

 | Mar 07, 2014 | 11:00 AM EST  | Comments
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The pundits have been wrong on the direction of interest rates so far in 2014. The consensus to begin the year, when the 10-year Treasury yield was hovering right at 3%, was that rates would slowly rise this year.

This would be driven by the Federal Reserve starting to taper its quantitative easing policy. And, as the economy accelerated above the 2% GDP growth level, that has been the norm over the five years since the recession ended.

It has not turned out that way so far. Ten-year treasury yields fell at the start of the year to 2.6% before recently rebounding above 2.7%. I am skeptical that we will get better than 2.5% GDP growth in 2014.  The Fed does look, however, as if it is committed to its drive to finish providing excess liquidity to the markets. This should allow rates to drift back up to 3%, if not a little above, over the next three to six months.

This would be good for financial stocks as banks see their net interest margins improve and insurers' investment portfolios are bolstered. The market might be starting to anticipate this development this week as financials have significantly outperformed the market over the past couple days of trading.

Goldman Sachs (GS) might be worth a look right now. The IPO market remains robust. I also think merger and acquisitions activity could pick up this year. Companies have done pretty much as much as they can to cut operational costs and organic growth remains hard to come by.

Most acquisitions we are seeing in the market are seeing the stocks of both sides of the deal rise as investors applaud these transactions. The shares are not expensive at just over 11x trailing earnings and approximately 1.2x tangible book value.

Bank of America (BAC) stock has performed strongly over the last few trading sessions and continues to be my favorite pick among the major banks. Of the majors, BofA should have the sharpest earnings growth over the next two years as earnings shoot to a projected $1.60 in FY2015 from 90 cents a share in FY2013.

After the Fed's stress tests are completed, the bank should also be able to reinstate a significant dividend later this year for the first time since the financial crisis. This is another financial that is trading for right around 1.2x tangible book value.

Europe is posting stronger economic readings in the New Year which should improve sentiment on European financial stocks. I still like the prospects of Netherlands-based insurer Aegon (AEG) even though it is up some 30% since I first highlighted it in July.

Even with its recent run, the stock sells for significantly less than book value. In addition, more than two-thirds of its revenue comes from the U.S. The shares trade for around 11x forward earnings and yield near 3%.

For investors who want to go out a bit on the risk curve I think Walter Investment Management (WAC) fits the bill. Mortgage servicers have been hit hard recently as some overly aggressive state regulators try to make some political hay on the huge increase in mortgages these firms are handling.

This is a predictable consequence, however, of some of the aspects of Dodd-Frank which has caused and will continue to cause banks to unload mortgage servicing rights (MSRs). My opinion is the current troubles are a 'hiccup' and these concerns will abate over time as these firms ramp up their servicing capacity.

Walter has been less targeted by regulators than Ocwen Financial (OCN) but the stock is down more than 25% from its highs late last year nonetheless. The shares are cheap at below 5x forward earnings and selling below book value.

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