We are late reporting the latest our SP 500 earnings update since I spent 2 days last week (Friday and Saturday) fishing one of a handful of lakes where “they” expect the next world record musky to be caught. Unfortunately, I didn’t catch it, and had to settle for 2 days in the Great Cold North (two hours north of Duluth, in the wonderful state of Minnesota), and two days of driving from there and back to Chicago, enjoying some of the most beautiful fall scenery on God’s Green Earth.
Oh well, back to reality.
Per Thomson Reuters, the “forward 4-quarter” estimate remained steady this past week, at $103.02, exactly the same as last week’s forward 4-quarter estimate.
The p.e ratio on the forward estimate after last week’s market drubbing is 14.6(x), while the PEG ratio fell back to 1.57(x) and you’ll see why in a minute.
The earnings yield on the SP 500 rose to 6.82%, its highest print since the August 1, 6.60% (and the date of the recent low for the SP 500 at 1,904).
More importantly, the year-over-year growth rate on the forward estimate jumped back to 9.32% its highest print since mid-August, 2014 and a very good sign for q3 ’14 earnings.
Analysis / commentary: Alcoa (AA) had strong earnings last week, and more importantly strong upward revisions to forward EPS and revenue estimates. With JP Morgan (JPM), Bank of America (BAC) set to kick off the big banks on Tuesday morning, followed by Wells Fargo (WFC), and then Citigroup (C) this week, and also the investment banks Morgan Stanley (MS) and Goldman Sachs (GS), by Friday morning we will have a very good look at the good chunk of the large-cap Financial sector, and expect decent, but not “lights-out” results from the sector. (Long all of the above except C, MS, and GS.) Technically an Industrial stock, GE reports on Friday, October 17th, 2014, but it is still very much a Financial, with GE Capital labeled a SIFI, so don’t kid yourself, Financial sector conditions still impact GE’s financial results.
Here is why I think Financials are a low-risk, low-reward sector:
- With the advent of Dodd-Frank and the rabid regulators, I don’t think the banks want to report strong results and instead want to fly under the radar and produce stable, low-volatility, results to avoid attracting attention;
- The big banks are shedding the higher risk businesses like the trading desks and scaling down the capital allocated to these businesses;
- Goldman and Morgan are PROBABLY still doing proprietary trading but not bragging about it, for the same reasons as above;
- The banks and major Financials, those labeled SIFI’s or Strategically Important Financial Institutions, have to really watch their P’s and Q’s. They have been neutered to a large degree and the shareholders wont likely see the EPS and revenue “upside surprises” that were important in the late 1990’s and mid 2000’s;
- I do think the major Financials have become as much “cost reduction” or cost containment stories to help leverage EPS growth; If the big banks do manage to generate more than mid-single-digit revenue growth going forward, I would be surprised;
- Both Goldman and Morgan Stanley have committed themselves whole heartedly to the asset management business which means more stable revenues, fees and less risky volatility; While the mid-term elections and a pro-business Senate might help to some degree, I don’t think we’ll ever return to the late 1990’s type financial environment, where the numerous regulators were completely vacuous, there was a “home-on-every-balance sheet” mentality, and the repeal of Graham-Leach-Bliley (GLB) was a disaster, all of which led to the 2008 Financial Crisis, which should have never happened.
- Unfortunately, the only entity left standing is the regulators;
- Basically the big banks and Financial’s are required to hold more capital, take less risk, which results in lower ROE’s, and have to ask the Fed and regulators for permission to pay dividends and make share repurchases. That is like asking your Mom or Dad for more allowance.
We are overweight Financial stocks in client accounts, but not by much. Financials comprise about 16% of the SP 500 by market cap. Our favorite Financial remains Charles Schwab, which we think is a huge beneficiary of “asset aggregation” and has a huge start on GS and MS, and does no trading with its balance sheet.
It is truly hard to say if easier regulatory standards makes for a safer Financial system. I still think the near-apocalyptic events that unfolded in late 2008, were a confluence of many events, not the least of which was a 60 – 70 year bull market in housing ending, Alan Greenspan said it best in the mid 1990’s in one of his many Humphrey-Hawkins testimonies when he said that “you can’t have a banking system where profits accrue to private shareholders, but losses are absorbed by the public domain (i.e. read taxpayer).
One of the reasons that the US economic growth slope or glide path off the 2009 low has been so tepid is partly due to the constraints on the Financial System, in my opinion. Some is demographics for sure, but the eternal question remains how do you allow what is a homogenous industry to foster growth and not be tempted to run the US economy into the ground ? We are still looking for a healthy earnings season for q3 ’14. Financials should show good numbers, too, but expect high single digit EPS and mid single digit revenue growth in the New, Post-2008 World we remain.
Financials might not be huge outperformers, but after the post-2008, regulatory world, I don’t think there is much risk to their results either. Credit is stable, revenues are stable, the risky businesses are being repelled and the dividends are decent.
Trinity Asset Management, Inc. by:
Brian Gilmartin,
CFA Portfolio manager