By John Wasik
CHICAGO Nov 9 U.S. financial services stocks
may be the most unloved sector in recent memory, but they may
end up prospering in the coming year.
Individual investors have had solid reasons to be sour on
financials since 2008. Earlier this year, JPMorgan Chase & Co
disclosed a $6.2 billion loss in trading as part of its
"London Whale" scandal. Bank of America Corp and
Citigroup Inc continue to struggle, and all of the
megabanks were involved in a legal settlement over the troubling
"robo-signing" of mortgage documents.
The balance sheets of the megabanks are still bruised and
hiding untold woes of bad debts; their share prices have largely
reflected uncertainty since 2008.
"Megabanks don't deliver good shareholder value," said
Sheila Bair, former Federal Deposit Insurance Corp chairwoman
and head of a nonprofit bank watchdog group called the Systemic
"They have a `complexity discount,' are too hard to manage
and their finances too opaque to the investment community," Bair
said in a speech at the Executive Club of Chicago on Wednesday.
Only 23 percent of Americans say they trust the country's
financial system, while banks got a slightly higher 33 percent
approval rating, according to the quarterly Chicago
Booth/Kellogg School Financial Trust Index released on Oct. 30.
The U.S. stock market, though, has not reflected the
public's dim view as the financial sector, which has been the
top-performing industry in 2012. Through Wednesday, the sector,
as measured by Standard & Poor's, was up about 20 percent this
year, nearly double the gain of the broader S&P 500 Stock Index
Keep in mind that the financial services sector encompasses
not just the largest banks but also smaller ones and credit card
issuers. More significantly, it includes insurers and
real-estate companies, which have both been participating in the
economy's rebound and have much stronger balance sheets than the
If you are looking for growth in your portfolio, start with
the regional banks, which typically have been conservative in
their lending standards and operations and have been bolstering
their balance sheets
Should you would like a capitalization-weighted approach,
then consider the iShares Dow Jones U.S. Regional Banks ETF
. One-third of the fund's portfolio is in two stocks:
U.S. Bancorp and PNC Financial Services Group Inc
The SPDR S&P Regional Banking ETF tracks an index of
76 mid-sized banks. It holds major players such as PNC
Financial, BB&T Corp and SunTrust Banks Inc.
No one bank dominates the portfolio, which employs an
equal-weighting strategy. Each stock comprises about 2 percent
of the fund, reducing concentration risk significantly. The ETF
was up about 16 percent for the year through Oct. 30.
Of the two funds, I prefer the SPDR, which also gives you
more of a sampling of the less-popular regionals.
For a broader mix of financials, the PowerShares Dynamic
Financials ETF offers more possibilities. It is a mix of
megabanks, regionals like KeyCorp and major insurers
like Allstate Corp. It also holds Class B shares of
billionaire investor Warren Buffett's holding company, Berkshire
Another alternative is the Vanguard Financials ETF,
which, in addition to the megabanks and regionals, offers a more
than 20 percent holding in real estate companies such as Simon
Property Group Inc.
My modest prediction that financial stocks will appreciate
even more is based on Congress resolving its debt ceiling/fiscal
cliff issues and no other financial calamities developing. I
also assume that the U.S. recovery will continue in tandem with
the Federal Reserve's continued easing policy and that
financials from regional banks to insurers will reap the
For no matter how Congress fumbles and fumes, the Fed said
it would maintain its low interest rates and keep buying
government and mortgage securities into 2014, when Chairman Ben
Bernanke's term ends. If the economy remains sluggish,
quantitative easing is likely to continue to bolster banks in
the near term. A low-interest-rate environment allows banks to
borrow at low rates and lend out at a profit.
A continued resurgence in housing and employment will also
help. Even increased regulation will strengthen banks.
The greatest caution with financials now is that they will
appreciate only as long as they are darlings of institutional
investors, inflation is relatively tame and the economic rebound
is on track.
Big banks, though, still face myriad unresolved issues. The
industry has been vigorously fighting regulation of its
profitable trading desks, which involve still mostly unregulated
How much systemic risk is still embedded in the system
because of bank-traded derivatives, also dubbed "financial
weapons of mass destruction" by Warren Buffett? No one quite
Only 30 percent of the Dodd-Frank financial reforms have
been implemented, and how the whole suite will affect banks'
earnings remains unknown. Many observers say that is a negative
Yet if you can largely avoid loading up on the largest banks
and stick with the regionals and insurers, you should be able to
weather the next storm somewhat better than with an all-megabank
strategy, which still has to be the ultimate contrarian bet.
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