Financials are now the best performing major sector in the market this year, after a very strong week on a relative basis. The financial sector, as measured by XLF, is up 21.5% in 2013, while the former leader, health care (XLV), is up 18.5%.
Here is the 1 year chart of XLF:
I don’t even need to draw the trendline – that’s about as steady a trend as you’ll find. The 50 day ma (pink) has acted as support on a couple occasions in 2013, and XLF hasn’t touched its 100 (green) or 200 day (black) ma’s since November 2012, more than 6 months ago.
So the technicals show a clear, strong uptrend, with the 50 day ma at 18.75 an obvious buy point on a pullback. What about the fundamentals?
Here’s a quick analysis of the top components of XLF:
- JPM – 9 P/E name with a 3% dividend projected to grow earnings 5% per year over the next 2 years. Has not had less than 10% earnings growth since 2008 (when earnings contracted 68%). Price to tangible book of 1.4.
- BRK/B – More of a holding company than a financial, but it’s a 20 P/E name projected to grow earnings about 13% over the next 2 years.
- WFC – 11 P/E stock with a 3% dividend projected to grow earnings 7% per year over the next 2 years. Also very consistent earnings growth over the last 4 years (none less than 15%). Price to tangible book of 1.87.
- C –12.5 P/E stock with 0.08% dividend projected to grow earnings 15% over the next two years. Price / Tangible Book 1.0
- BAC – 15 P/E stock with 0.3% dividend yield projected to earn 1.32 in 2014 (so 10x 2014 earnings). Has had a much worse earnings record than its peers over the past 4 years. Price / tangible book of 1.0.
Those 5 names make up almost 40% of the XLF ETF, and they’re all up substantially on the year.
Here’s the thing about financials – they look much cheaper than the rest of the market. Of course, that’s for good reason, given the past volatility of their earnings stream, the overhang of new regulations, and the massive leverage of their balance sheets. But in an environment where utilities and staples stocks are trading at 20 P/E valuations, investors are more and more willing to give this sector the benefit of the doubt, particularly when the valuation gap is so large.
As long as systemic risk emanating from European banks remains subdued, financials should have the all-clear signal to continue to outperform the broader market, given the strong capital markets backdrop and their cheaper valuations than other sectors. In that sense, holders of U.S. financials names should keep a close eye on the price action in the European banks.
Full Disclosure – as a former employee, Goldman Sachs is my largest personal stock position.