Frustrating Financials: Like the SP 500, Seeing a Year of PE Compression ?

Seasonally, the SP 500 is entering one it’s strongest periods of the calendar year.

The SPY’s YTD total return as of Friday, 10/19/18, was about 5%, while the XLF and KRE ETF’s returned -3% and -6% respectively, YTD.

Client’s largest financial position for most accounts is Charles Schwab (SCHW), which is now down 8% in calendar ’18, being offset to some degree by CME’s 26% YTD return, and JP Morgan’s +3% YTD return.

Refinitive IBES noted with this weeks earnings look, that Financial sector earnings growth for Q3 ’18 will be 44.5%, which is being boosted by the multi-line and P&C insurance businesses and the hurricane season from Q3 ’17, so if those two sectors are excluded, the expected Financial sector earnings growth falls to 33.7%, still not too shabby.

The top SP 500 Financial weights:

  • #4 weight: Berkshire at 1.7%
  • #7 weight: JP Morgan at 1.5%
  • #10: Bank of America at 1.12%

(Source: Morningstar data)

Expected revenue growth for Q3 ’18 for the Financial sector is 8% and for the 4th quarter, Refinitive IBES is expecting 4% revenue growth, while Factset is expecting 3.4% and 4.7% respectively.

The earnings growth for the sector is there, but the return is not, not unlike the SP 500 in 2018, which is seeing 23% y/y earnings growth, but the YTD return for the SPY is just 5%.

Summary / Conclusion: Can the Financial sector play catch up with the SP 500 into the final months of 2018, assuming that we get a seasonal market rally into year-end 2018 ? The best years for the Financial sector, such as 2013 and 2017, were also good years for the SP 500, returning 32% and 22% respectively.

Chris Verrone, the excellent technician at Strategas Partners, came through Chicago this summer and noted that – in his opinion – the three value sectors within the SP 500 were Energy, Industrials and Financials.

Schwab is Trinity’s largest individual Financial sector position currently, (and has been for close to 7 – 8 years, maybe longer) and I do think the stock is still 10% – 20% undervalued. The drag on the stock is the price war happening within the traditional “discount broker” sector, with firms like Fidelity and TD Ameritrade. Commissions have been cut to $4.95 the last few years and Fidelity launched a set of “zero” cost market index funds that have a zero expense ratio. Eventually I think Schwab gets to zero commissions, as does the rest of the sector. These former “discount brokers” are now asset gatherers, with Schwab’s $3.5 trillion in assets under management dwarfing TD Ameritrade, and even Goldman Sachs and Morgan Stanley. (Fidelity is still a private company, but it looks like their assets under management are $2.1 trillion.)

Schwab grew EPS this year 50%, a lot of it tax-rate reduction aided, so ex the tax cut, I’d suspect Schwab still would have grown EPS 20% in calendar ’18 and is expected to grow EPS 17% in 2019, with a 16x multiple on the stock.

A more in-depth, bottom-up, research piece will be posted to Seeking Alpha in the next 24 – 48 hours on Schwab. Check the SA site for a more detail and valuation work.

Thanks for reading.





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