Last week was all about the big financials. The industry took
center stage, with nearly all the big players reporting results
for their most recent quarters.
Overall, it was a pretty upbeat week for the sector. There
were a couple earnings misses here and there, but overall the
theme of the week was positive, and that the financial industry
remains in good health.
JP Morgan (
) got the ball rolling on Tuesday morning. The bank reported a
7.3% drop in earnings, mostly a result of legal costs. Taking out
the legal expenses, the company earned $1.40 a share, on revenues
of $24.1 billion. Wall Street expected earnings of $1.35 on
revenues of $23.67 billion. In the days following the report, the
stock has traded slightly higher.
Wells Fargo (
) was another closely-watched bank that reported on the same day
as JP Morgan. It also had upbeat numbers, topping analyst
estimates for both earnings and revenues. The company had
earnings of $1.00 per share, which topped estimates by two
pennies. It had year over year earnings growth of 10%, but its
revenues, while topping estimates, were down 5% from the same
period last year.
Then, we have some ugly reports, most notably Citigroup (
). That company reported its earnings on January 16, and the
stock took a big hit following the report. Analysts expected
earnings of 95 cents per share, but actual earnings were much
lower at just 82 cents. Revenues during the quarter were $17.8
billion, down 1% from the previous year. The silver lining to the
disappointment was that income was up 21% year over year, just
lower than expected.
Goldman Sachs (
) also disappointed, while Bank of America (
) and SunTrust (STI) both put up strong numbers.
While not everything has been great with the earnings from the
sector, overall it has been a positive week, which should help
keep upside momentum in bank stocks moving forward. However,
there are enough warning signs to take a guarded approach to
playing the sector.
One recurring theme this earnings season has been a drop in
mortgage lending. This is a result of rising interest rates, and
it is reasonable to assume that the trend will continue as rates
inch higher through 2014 now that the Federal Reserve has begun
tapering its monetary easing program.
The lower mortgage lending is a reason for concern, but what
this earnings season tells me is that the drop is being offset by
improved credit quality, which I expect to continue.
Overall, I am bullish on the sector, but realize that enough
risk exists to make sure than any new investments in the sector
are highly diversified, and with some acceptable level of
downside protection in case rising rates start to have a greater
impact on earnings.
A good diversified play on the sector is the exchange-traded
fund iShares US Financials (IYF). IYF tracks the results of the
Dow Jones U.S. Financials Index, so you can diversify over all
the major financial institutions. Among its top holdings are JP
Morgan, Wells Fargo, Berkshire Hathaway (BRK.B) Bank of America,
With IYF holding so many of the major financial stocks, you
are able to play the sector, but protect yourself against any
downside in the event that a couple of the major banks run into
some trouble. Setting up a hedged trade on IYF can provide
additional protection, allowing us to still pull in a nice return
even if the entire sector turns negative.
A nice hedged trade on IYF would be the May 70/75 bull put
credit spread. In this trade, you would sell the May 75 put while
buying the same number of May 70 puts for a credit of 25 cents.
This trade has a target return of 5.3%, which is 16.0% on an
annualized basis (for comparison purposes only). IYF is currently
trading at $80.69, so this trade has 6.7% downside