9.19.14: Warming up to the Financial Sector

Coming into 2014, we thought the SP 500 could generate $120 in earnings per share (EPS) for the calendar year.

Today, the SP 500’s 2015 consensus estimate as it (they) stand right now:

2015 current bottoms-up consensus:$133.54

2015 current top-down consensus:$127.32

2015 current consensus “average”: $130.43

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2014 current bottoms-up consensus : $118.76

2014 current top-down consensus: $117.49

2014 current consensus “average”: $118.13

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With the average 2014 consensus estimate of $118.13, there is still a chance that we could see $120 by April 1, ’15 (remember, we don’t get the final 2014 number until all companies report their q4 ’14, which isn’t set in stone until the 4/1/15), but the Financial sector write-downs this year, are not helping.

The point of the above is that the SP 500 remains on track to generate 10% EPS growth in calendar 2014 (or close to it), and at least at this early stage, low teens growth in 2015.

This is normally a market environment where Financials outperform, but the stocks like JPM are underperforming the SP 500 this year, particularly JPM and C. BAC is performing in-line with the SP 500 year-to-date.

Bank write-downs

Citigroup reported $0.03 per share in EPS in the 2nd quarter, although after the mortgage settlement charge is removed, operating EPS was $1.27 per share.

Bank of America’s write-down has resulted in an EPS estimate of $($.09), i.e. a nine cent loss for the quarter, after an original estimate of roughly $0.31 per share.

Ignoring EPS for a minute, here are the total dollar write-downs for the Big Banks since JP Morgan last fall:

Bank of America: $16.6 billion;

JP Morgan: $13 billion;

Citigroup: $7 billion

This is the primary reason we are starting to warm up to the Financial Sector coming into late 2014, and in particular 2015. The books are getting cleaned (or cleared) of the overhang of the litigation mess left over from the 2008 Mortgage Crisis, and it is setting the Financials up, particularly the big banks, for a cleaner year and easier compares next year.

Per Greg Harrison of Thomson Reuters, “Currently, 2014 earnings growth for the S&P 500 is estimated at 8.2%, and the Financials sector is estimated to grow 3.2%.  If the $0.43 legal charge for BAC and the $1.24 charge for BAC are excluded, the overall growth estimate rises to 9.0% and the Financials estimate rises to 7.4%.”

Here is the progression of 2014 growth estimates for the Financial sector:

9/12/14: +3.2%;

7/1/14: +6.6%;

4/1/14: +9.3%;

1/1/14: +10.9%

Even if we exclude the write-downs in 2014, you can see that 2014 was a tougher year for Financials as there has been downward pressure on the growth estimates all year, despite the fact that the SP 500 is still on track for 9% – 10% growth in calendar ’14.

For calendar 2015, here is what Thomson Reuters consensus sector growth estimates for Financials and the SP 500 as of:

9/12/14: +16.6%, and +12.5% for SP 500;

7/1/14: +12.5% and +11.5% for SP 500

4/1/14: +11.3%, and 11.5% for SP 500

2015 consensus sector growth estimates as of right now (and it is still early) is that Financials will have faster earnings growth than the SP 500 in calendar 2015.

One last comment: as Taper ends, and the yield curve starts to steepen again, if only slightly, Financials have found a bid since the 10-year yield bottomed in mid-August ’14. Looking at the charts of JP Morgan (JPM), Goldman Sachs (GS), Bank of America (BAC), Morgan Stanley (MS), Charles (SCHW), all the stocks bottomed or ended their consolidation in early August ’14 and started to move higher at the same time. (Long JPM, WFC, BAC, SCHW)

2015 sector growth is setting up nicely for the Financials as of right now. We’ll be looking for revisions after the October ’14 earnings reports.

We spotted a similar pattern in late 2012, when looking ahead to 2013.

Financials are the market generals: although Dodd-Frank, tougher mortgage underwriting, and much tougher regulation has crimped earnings growth, the fact is that while banks EPS growth might be slower, it should be less volatile over time. The credit cycle hasn’t been repealed, but looking through 2015, we think next year will be a better year for the sector.

(If you are wondering why we started with 2014 and 2015 SP 500 EPS estimates and the various consensus prognostications, we wanted to lay the backdrop for why Financials can outperform next year. )

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

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