Financial Stocks Will Start Q2 From a Happy Middle Ground

by Dan Burrows | March 29, 2013 9:55 am

QuarterlyReviewOutlook185[1]Sometimes, being first is overrated.

The broader financial sector and bank stocks had a good, if not great, first quarter, which is actually something of a relief. If we do get our annual spring and summer swoon — the markets have gone into second-quarter correction mode[2] for three years running — then financials won’t have as many gains to give up.

At the same time, if financials get a second-half earnings acceleration — as Wall Street is expecting — they’re poised for outperformance back on the upside too.

The financial sector has been beating the broader S&P 500 so far this year, but it’s by no means the hottest part of the market.

As of March 27, financials gained 10.7%, trailing healthcare (14.1%), consumer staples (13.2%) and the consumer discretionary sector (11.4%). By comparison, the S&P 500 is up 10.2% on a price basis for the year-to-date through March 27.

Still, broad bets on financials and banks have put up handsome returns, and — remember — the higher a stock or sector flies, the harder it falls if and when equities turn south.

The popular financial exchange-traded fund — the Financial SPDR (NYSE:XLF[3]) — and the big bank ETF — SPDR KBW Bank (NYSE:KBE[4]) — are doing quite well in 2013, but not exactly shooting the lights out.

Have a look at the chart, courtesy of S&P Capital IQ, below:

Banks CHART[5]

Stupendously low valuations (in many cases, financial firms are trading below book value), firehoses of liquidity from the Federal Reserve and other global central banks, and risk-on, pro-cyclical market action are just a few of the updrafts that have been lifting bank stocks.

And now a bunch of fundamentals are looking better too.

For good, old-fashioned banking, the much-improved housing market is driving strong results in mortgages and refinancings. Indeed, we’ve become accustomed to mortgages delivering any good news at the big money-center banks like Wells Fargo (NYSE:WFC[6]), Bank of America (NYSE:BAC[7]), JPMorgan Chase (NYSE:JPM[8]) and Citigroup (NYSE:C[9]).

Banks have been setting aside less money to cover loan losses for a while now, so that’s not really been what holding the biggest names back. Rather, it’s been a dearth of deal activity and dead quiet capital markets.

But now, lo and behold, the industry is picking up. Initial public offerings, mergers and acquisitions and leveraged buyouts are back in a big way.

That matters little to the regional banks — and less to a firm like Wells Fargo — but  boy is it good news for Bank of America, JPMorgan and Citigroup, all of which need their investment banking arms to pull their weight.

Increasing deal activity and percolating capital markets are even more critical to investment banks like Goldman Sachs (NYSE:GS[10]) and Morgan Stanley (NYSE:MS[11]).

Wall Street sees the financial sector hitting an earnings trough when first-quarter results come out in a few weeks. Sector earnings are forecast to grow just 2.9%, according to data from FactSet. That’s down sequentially from 16.6% in the fourth quarter of 2012 and 11.7% posted in Q3 of last year.

But the past is the past, and the market is forward looking. Analysts see the second quarter kicking off a return to double-digit profit increases for the remainder of 2013, led by firms such as Bank of America and Citigroup.

If markets correct during the second quarter, the financial sector and the bank sub-sector will by no means be spared. But they shouldn’t take the worst of the beating either. And if the market rallies into year-end like it has the last several years, double-digit earnings growth should ensure financials place on the leader board.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. [Image]:
  2. second-quarter correction mode:
  3. XLF:
  4. KBE:
  5. [Image]:
  6. WFC:
  7. BAC:
  8. JPM:
  9. C:
  10. GS:
  11. MS:

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