Financials – Trading like It’s 1994 (Again)

One of the classic years we saw “PE compression” was 1994, when Alan Greenspan really caught the Street and the investment community off guard, and raised the fed funds rate 6 times that year, after a surprisingly-strong Q4 ’93 GDP report resulted in an emergency meeting for the FOMC in the last days of January ’94.

SP 500 EPS grew 20% and the SP 500 returned 1% in the calendar year, not helped either by the peso devaluation in November ’94 and the Orange County Comptroller nearly sinking the County after investing in PO’s (principal-only mortgage strips, if memory serves) that lost a lot of value over the 12 months.

So what’s the point of the history lesson ?

Financial’s are acting in 2018 just like they did in 1994. Maybe not all of the downside we saw that year after a steep yield curve from 1991 to 1993 really juiced the Financial stocks, but dead money this year is the only way to describe the Financial sector.

Year-to-date returns of major Financials stocks and ETF’s:

  • XLF: +2.31%
  • KRE: +8.06%
  • JPM: +8.72%
  • SCHW: -0.49%
  • CME: +20.60%

Client’s are long every one of those names, and all are in the “top 10” client positions on a firm level. By percentage weight, Schwab is #1, JPM is #2, CME is #3, KRE is #4 and XLF is #5 ranked in order by Financial sector only.

Readers will be updated with our Top 10 holdings on October 1, but Microsoft remains client’s #1 position and has been for the last 6 years (when ValueAct took the 1% position in April, 2013.)

Here is how the numbers (expected EPS growth for the Financial sector by quarter) look for the Financial sector per Thomson Reuters IBES estimates:

  • Q2 ’19: +8.6%
  • Q1 ’19: +8.1%
  • Q4 ’18: +28.3%
  • Q3 ’18: +45.5% expected EPS growth, +3.3% revenue growth
  • Q2 ’18: +27.2%, +8.1% revenue growth (these numbers are won’t change since all Financial components of the SP 500 have reported Q2 ’18 earnings)

What’s most interesting is that on July 1 ’18, Financial sector revenue was expected to grow at 4.5%, it actually grew at 8.1%.

That’s a good sign.

So what’s holding back the sector and the stocks ?

Well, the Fd is raising rates and shrinking the balance sheet. Loan growth looked good in Q2 ’18, credit reserves continued to be released, in fact credit looks great, net interest margin’s (NIM’s) are expanding, and yet the stocks and sector remain moribund.

Here is the historical EPS and revenue growth numbers for Financial’s:

  • Q2 ’18:  EPS +27.2%, revenue +8.1%
  • Q1 ’18:  EPS +30.7%, revenue +2.2%
  • Q4 ’17:  EPS +14.6%, revenue +4.4%
  • Q3 ’17:  EPS -7.3%, revenue +2.2%
  • Q2 ’17:  EPS +12.2%. revenue +4.1%
  • Q1 ’17:  EPS +19.9%, revenue +4.8%
  • Q4 ’16:  EPS +11.6%, revenue+4.0%
  • Q3 ’16: EPS +8.5%,  revenue +6.9%
  • Q2 ’16: EPS -4.0%, revenue +0.9%
  • Q1 ’16: -10.4%, revenue -1.2%

(Source: Thomson Reuters IBES historical earnings data)

Q2 ’18’s revenue growth of 8.8% was the strongest quarter of revenue growth for the Financial sector since Q4 ’12, and I dont know what happened in Q4 ’12 to produce a 20% revenue growth rate for the sector. Certainly 2013 was a great year for Financial stocks.

So (again) what’s the point ?

Note the trend in Financial sector revenue the last 8 – 9 quarters – at some point PE’s should expand for banks, brokers, insurance companies et al.

Treat the dormant Financial sector in 2018 – and this is just one opinion – as a reason to accumulate the sector, however you wish to do it. I’m still partial to banks, and the old discount brokers like Schwab. Goldman and Morgan Stanley are the last bull market’s brokerage model. The stocks trade like drek.

Be patient with Financials – they will pay off, maybe not like 1995 when the SP 500 rallied 37.58%, but the sector should generate some alpha on the back of stronger GDP and strong sector fundamentals.

Thanks for reading.


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