Despite the massive flameout in many financial stocks, the current environment is ideal for investing in financial firms. Eighteen months ago, I said that the Financial Sector ETF (NYSE:XLF) was “a speculative buy if it drops below $12 per share.” It did, and today the XLF is over $18. As well as it’s done, the fundamentals of the financials are still remarkably strong. This is excellent news for stocks on our Buy List like JPMorgan (NYSE:JPM) Wells Fargo (NYSE:WFC) and Nicholas Financial (NASDAQ:NICK).
Let’s run down some of the reasons why the financial sector is so appealing. The biggest is that the Federal Reserve is keeping short-term interest rates near 0% and has promised to keep them there for some time. The Fed’s position clears up a lot of uncertainty, and Wall Street likes it that way. Another big reason in favor of financials is that the economy is slowly improving. At a firm like Nicholas Financial, the overall quality of their loan portfolio has improved dramatically.
We also have to look at the mortgage market. For obvious reasons, many financial stocks are closely tied to the mortgage market, and the U.S. housing sector continues to improve. Thanks to Bernanke and his friends at the Fed, the bond-buying policy has pushed down mortgage rates and they’ll probably stay low. This time, the improvement in the housing market is far sounder and more sustainable than it was last decade. Let’s not forget that lending standards have thankfully improved.
Another key point is that valuations for many financial stocks are still quite modest. JPM just broke though $50 per share and it’s going for less than nine times Wall Street’s estimate for next year’s earnings. Based on Thursday’s close, JPM yields 2.4% and I’m expecting the bank to raise its dividend soon. I think the current 25-cent quarterly dividend will go up to 30 cents per share. That would still be less than 22% of their full-year earnings.
Given the current environment, I doubt many investors will be able to beat XLF this year or do it with less volatility. We’re going to look back at this era as a great time to buy financial stocks.