The financial sector was expected to perform well this year, amid hopes that a strengthening housing market and the Federal Reserve’s interest rate hike would help the bottom line of banking stocks.
It hasn’t quite worked out that way.
Instead, the financial sector is the worst performer this year, down about 10 percent so far, with the banking subsector tarring the rest of the related businesses. Worries about the global economy, the Bank of Japan’s move to negative interest rates, concerns about the health of some European banks and expectations the Fed won’t raise the federal funds rate as much as originally expected have all taken their toll.
Given the weakness in the sector, Wall Street analysts say this may be a good time to hunt for selective bargains that don’t include banks.
Economic worries are stressing financials. Greg Estes, disciplined value fund manager at Intrepid Capital Management in Jacksonville Beach, Florida, says investors rotated out of financials during February’s sell-off because of macroeconomic issues and into more defensive sectors like utilities.
Brian Frank, chief executive officer and portfolio manager at Frank Capital Partners in Key Biscayne, Florida, says despite the Fed’s widely anticipated interest rate hike in December, the impact on the broader market has not been kind.
“The market is begging the Fed not raise interest rates four times this year. We saw the knee-jerk reaction in Japan when they went to negative rates, and when (European Central Bank President) Mario Draghi painted again he might actually do something (to stimulate Europe’s economy),” he says.
The Fed’s December interest rate hike of 25 basis points was counter to what is happening with other global central banks, which are trying to stimulate their economies. The U.S. economy is showing some growth, with job creation and strong consumer sentiment, which is why the Fed opted to raise rates.
Analysts initially thought the Fed would raise rates four times this year. However, the drop in U.S. and foreign stock markets and concerns the U.S. economy could be affected by the weakness elsewhere has many believing that the Fed will limit rate hikes.
Analysts at Deutsche Bank cut their 2016 estimates for bank earnings per share based on the likelihood of fewer Fed rate hikes. They forecast bank earnings per share to be down 5 percent this year, rather than up 5 percent, as only one or two Fed hikes late in the year won’t raise the average 2016 Fed funds rate much.
Low rates means that banks can’t get more of a cushion on the spread, or difference, between what they offer depositors to keep money with them and what they loan out.
Where to look instead. The overall weakness in the financial sector means some names, such as American Express Co. (ticker: AXP), are being unfairly punished.
“That has been completely annihilated,” Frank says. “I think it’s at a single-digit price to earnings now. There are definitely competitive pressures there, and (if) the economy is rolling over, you need to keep an eye on their credit quality and the defaults on credit card payments.”
However, he says American Express has franchise value, unlike other credit card issuers. “People still use an Amex card because of all the intangible stuff — the concierge, the Amex travel, the way they go to bat for you when you have a dispute. Those are tough for other credit companies to compete on. From a long-term perspective you’ll get there, but in the short term it could get beat up more,” he says.
Estes follows Oaktree Capital Group (OAK), a distressed debt investment firm that has had cash sitting on the sidelines. But in a recent earnings call, company officials say they are seeing more opportunities in the energy, retail and media sectors.
“When things get uglier, then there will be more opportunity for them. They need a rough patch, a dislocation so they can make those investments. It’s kind of a contrarian idea in financials,” he says.
OAK stock is expensive, with a hefty price-to-earnings ratio of 32, but the company’s stock price is down 10 percent in the last year, so investors initiating a new position would be buying on a dip.
Estes says Intrepid Capital owns a convertible bond from Ezcorp (EZPW), a pawn shop company, as well as bonds from pawn-shop operator First Cash Financial Services (FCFS), because of high yields offered with both stocks. Rising gold prices should give pawn shops a chance to benefit from inventory held from the last time gold prices were high, around 2010.
“Pawn shops are defensive in nature. If the economy gets worse, then pawn shops seem to do OK. Now on the regulation side, anyone in the pawn shop business had to move from payday loans and predatory practices. Both of these companies did that. There was some impact on their cash flows, but moving forward you can look at them strictly without having to worry about (concerns about payday loans) since they’re out of it now,” he says.
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Financial Sector Is Struggling, But Some Bargains Are Available originally appeared on usnews.com
