Any student of the stock market should appreciate the resurgence of financial stocks. These were the stocks that the market loved to hate, not just in the immediate wake of the financial meltdown of 2008 but right through most of 2011.
For about two and a half years of market recovery, financials continued to be tarred with a negative monolithic brush. Finally, in late 2011, the disparity between solid business recovery and continuing market negativity reached such a point of absurdity that the sector finally started to get some favorable attention.
Financials had a strong 2012. In the course of the next two articles, we will set forth why there are more gains to be had in the sector in 2013, and where.
We have been very bullish on financials. In our year-end sector outlook last month, we called for financials to continue their strong 2012 performance into 2013. Our early read on the fourth-quarter earnings season confirms and reinforces our positive outlook.
Here are a few brief updates on some of our past recommendations. Overall, most recent earnings have ranged from in-line to better than expectations. Revenues, however, have been in-line to modestly below expectations, as the record low interest rates squeeze net interest margins for the entire group. Furthermore, elevated regulatory and legal costs continue to pressure revenue and earnings.
Fortunately, most areas of the sector continue to improve and strengthen, as follows:
- Foremost, credit trends continue to improve and are actually getting back to pre-financial-crisis levels.
- Investment banking and trading are also having a nice rebound.
- Mortgage units have experienced a pickup in purchasing and refinance activity amid record low interest rates.
- Credit card businesses are back and are reporting record consumer spending and activity levels.
- Regional banks continue in the right direction, but business is being disproportionately hurt by net interest margin pressures.
Overall, fourth-quarter business was good, and outlooks for 2013 were positive and should improve as the year progresses. While financial stocks continue to sell at reasonable valuations, they are not as cheap as they were in the last few years. They are, however, finally starting to get some business momentum, and investor sentiment is warming up. Stock repurchases and rising dividends should start after the Fed stress tests and all regulatory requirements are known and complete.
In many cases, as in the past few quarters, the stocks have been weak the day of their earnings announcements. Short of real company-specific issues or setbacks, we would be buyers into that weakness on earnings days when a company meets or beats expectations. We believe that these stocks will likely start to move higher after earnings season.
Here are few recent highlighted reports:
JPMorgan (JPM) reported better-than-expected earnings of $1.39, compared with a $1.19 consensus. Rising fee income from mortgage and investment-banking operations drove the upside to the numbers, and years of cost-reduction efforts also added to the bottom line. Management continued to affirm strong market-share gains and a continued recovery in the businesses. Among the major financial institutions, JPMorgan sells at a relatively low valuation of less than 9x 2013's earnings. In a year that included the "London whale" trading debacle, the company still earned $5.20 per share and had a 15% return on tangible equity and an increase in its tangible book value of $5.06 per share ($38.75 per share, compared with $33.69 a year earlier).
American Express (AXP) reported better-than-expected billings growth of 8% and in-line revenue and earnings. The company initiated several aggressive cost-reduction actions. Management also affirmed the long-term outlook of 10% earnings growth in 2013 and beyond. American Express has an attractive valuation level of 12.7x earnings.
Wells Fargo (WFC) reported better-than-expected revenue and earnings growth led by rising fee income and falling credit and operating expenses. The net interest margin continued to shrink, but the overall outlook goes unchanged; the company expects double-digit earnings growth over the next several years. Wells Fargo is attractively valued at less than 10x 2013's expected earnings.
On Tuesday, we will continue our sector review and provide some additional thoughts about the prime opportunity that we envision for financials this year.
