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Is the Financial Sector Finally Poised to Realize its Potential?

By: OptionsANIMAL
Posted: 11/28/2012 3:59:00 PM
Referenced Stocks: BAC;C;GS;MS;SPY;XLF

By Greg Jensen

For obvious reasons, the U.S. financial sector was one of the hardest hit areas of the market during the “Great Recession.” The Financial Select Sector SPDR Fund (XLF) fell from highs over $38 to a low around $6 in just over a year-and-a-half as Lehman failed and AIG tottered on the edge. The recovery, up to a point, was even faster. From a low close of $6.18 at the beginning of March 2009 XLF rallied to over $17 in around a year. Then it stopped.


As you can see, XLF has struggled since then, consistently underperforming the S&P 500 tracking ETF, SPY. Most people know the reasons. A sluggish (at best) housing recovery, a potential crisis in Europe, the fiscal cliff, and changes in capital requirements are usually quoted. With the exception of capital requirement changes, all of these things are problematic for the economy in general, yet the overall market has continued to recover, leaving financials behind. Individually, large banks have done no better. Goldman Sachs’ (GS) lack of exposure to the consumer has led to their recovering better than most, but Citi (C), Morgan Stanley (MS) and Bank of America (BAC) have all struggled since that initial recovery.

Profits in the sector have returned to levels not seen since 2007, yet the stocks remain stubbornly depressed. There are sound reasons for this. Much of the increased profit has come as banks cut back. Thousands of jobs have been lost and branches have been closed. Litigation issues stemming from the collapse remain for many. In many ways the financial sector still looks like an industry in decline, but I believe that the poor stock performance is now down to something more human; distrust.

It can be hard for those of us that crunch numbers to accept that emotions, not objective analyses, often drive markets in the short term, but the image of invincibility that large financial conglomerates once had has gone. Every bit of bad news for the sector sees the stocks get hammered, while good news is treated with caution. There is an element of “once bitten, twice shy” to this. Most investors, whether on Wall Street or Main Street, have been burnt by financials at some point. They are understandably reluctant to get involved again.

In the long term, however, improving conditions and profitability will win out. Many of the real factors that have caused worry are showing signs of improvement. Evidence of a recovery in housing has emerged. The EU has shown some willingness to do what it takes to avoid disaster. Increased capital requirements have led to stronger balance sheets at major banks. Law suits are being settled from provisions already made. Even politicians are beginning to sound reasonable! Now may, finally, be the time.