Goldman's investment arm says bank stocks are top pick for 2013

Fri Jan 11, 2013 3:25pm EST

Jan 11 (Reuters) - Goldman Sachs Group Inc's investment-management arm is telling clients that the best place to put their money this year is in stocks of U.S. banks, even after their recent run-up.

At the same time, Goldman Sachs' wealth management arm is advising investors looking for higher returns to shun U.S. Treasuries, most other bonds and even hedge funds, warning that most hedge funds will generate only mid-single-digit returns.

"There will be lower returns across all asset classes," Sharmin Mossavar-Rahmani, chief investment officer of Goldman Sachs' investment strategy group, told a press briefing on Friday. "We think this is a very important message, but not everyone likes to hear it."

The investment strategy group has been advising clients to put their money in bank stocks for two years. The firm said it made that investment its top pick for 2013 because the low-interest-rate environment has rendered financial stocks particularly undervalued.

Investors have been shunning big bank stocks for years, citing a weak economy, volatile markets and new regulations that have clamped down on earnings potential. Until a recent rally begun toward the end of 2012, shares of some of the largest U.S. banks, including Goldman's own, were trading below the stated value of assets on their balance sheets.

But last year, bank stocks gained significant ground, particularly in the final months of 2012. The SPDR S&P Bank ETF , which Goldman's investment management team uses as a basis for its investment thesis, rose 20 percent last year and is up another 5 percent in the first few weeks of 2013.

Some stocks included in the ETF, including Bank of America Corp, more than doubled in price last year. The ETF, which invests in a group of 41 U.S. commercial banks, counts Citigroup Inc, SVB Financial Group, Ocwen Financial Corp, Comerica Inc and Bank of America as its top five holdings.

Goldman's case for further growth in bank stocks in 2013 is three-fold: attractive valuation, even after the rally; potential for bigger dividends now that capital levels have improved; and the idea that investors can use bank stocks as an easy play on the housing recovery, since more than half of U.S. banks' loan books are comprised of U.S. real estate.

Brett Nelson, a managing director in Goldman's investment strategy group who presented the case for bank stocks, forecast that banks will be able to reach an 11 percent return-on-equity even with new regulations - less than their historical 15 percent return-on-equity but still better than single-digit levels that banks have recently been reporting. Return-on-equity is a measure of how much profit a company can wring from its balance sheet; it is monitored closely by bank investors.

An 11 percent return-on-equity would imply a valuation of 1.4 times book value - still much higher than the level banks are now trading at, which is roughly equal to the value of assets on their books.

"If the concern is that banks are becoming utilities (because of new regulations), then that's fine," said Nelson, noting that the utility sector has a 10 percent return-on-equity and trades at 1.4 times book value.

The amount of capital banks can return to shareholders through dividends this year will also be a big driver of stock performance, he said.

"Banks will be the fastest grower of dividends," said Nelson, who predicts that dividend yields in the sector will exceed that of the S&P by year-end.

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