ETFs

The Health of The Financials

By Kevin Grewal

The financial sector has more than doubled from its March 2009 lows and with fourth quarter earnings reports indicating signs of profits many suggest that the wounds inflicted on the sector have been healed.  However, when dissecting the numbers even further, there are signs that indicate that weakness may still prevail.

Most recently, JP Morgan Chase (JPM) posted earnings of $3.3 billion for the fourth quarter of 2009, beating analyst expectations, painting a prettier picture than last year and setting an upbeat sentiment for Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), and US Bank Corp (USB), all expected to release earnings this week. 

When analyzing the results, it appears that the profits were primarily driven by the firm’s investment banking and trading operations.  As the global financial crisis unleashed it took its toll on equities making them cheap and enabling traders to buy them at historically low prices, bidding up prices and booking huge profits.  Now that some experts and analysts suggest that securities are reaching their true values, the ability to make these easy trading profits will likely be hindered.

On the positive side, the outlook for mergers, acquisitions and initial public offerings (IPOs) is somewhat bright.  In fact, a recent study revealed that venture capitalists expect IPO activity and venture-backed funding to increase dramatically in the coming year.

 As for retail financial services operations, which are a huge portion of the financial sector, the trends are not too promising.  A weak housing market, high unemployment and shaky consumer confidence continue to take their toll on residential loans as credit losses continue to mount and loan-loss reserves continue to balloon.  In fact, consumer loans are shrinking and November 2009 showed the biggest drop in consumer credit on record.  This can be detrimental to the overall financial performance of these firms in that it is a highly profitable portion of their overall business.

On the commercial side, things are not much better.  Many suggest that the commercial real estate sector is going to take a hit in the coming year.  Additionally, businesses are reluctant to take out additional loans, which has resulted in a double digit decline in year on year commercial and industrial loans, another huge money maker for financial firms. 

Lastly, the special 10-year fee on large financial companies that President Obama is proposing will likely be a downer on the sector.  This fee, which is expected to generate nearly $90 billion over a 10-year period and repay taxpayers for preventing the economy from completely collapsing, will more likely than not eat away at the bottom line of large financial institutions. 

In a nutshell, bank earnings will likely be better than they were a year ago, but it appears that they are not being driven by the consumer and as long as unemployment remains high and consumers refuse to take on credit, the sector will likely have an uphill battle to fight.

Some ETFs to watch as the financial institutions unveil earnings reports include:

  • the Financial Select Sector SPDR (XLF), which closed at $15.25 on Friday
  • the iShares Dow Jones US Financial Sector Index Fund (IYF), which closed at $54.29 on Friday
  • the Vanguard Financials ETF (VFH), which closed at $30.51 on Friday

The financial sector as a whole has been in a nice uptrend, but it is important to keep in mind the risks involved when investing in it.  A good to way to protect against these factors risks is through the use and implementation if an exit strategy which triggers price points at which an upward trend could potentially be coming to an end. 

According to the latest data at www.SmartStops.net, the price points for the aforementioned ETFs are: XLF at $14.57; IYF at $52.18; VFH at $29.37.  These price points fluctuate on a daily basis and reflect changes in market conditions.  Updated data can be found at www.SmartStops.net.

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