While Rising Rates, Regulatory Ills Take a Toll, the Long View Looks Better
By Chet Currier
Bloomberg News
Sunday, May 22, 2005
As ugly as early 2005 has been for stocks in general, it has been worse for owners of financial stocks and financial services mutual funds.
Through May 13, the average among 45 financial sector funds tracked by Bloomberg posted a 7.5 percent loss. That compares with an average 5 percent decline suffered by stock funds of all types.
No surprise, given that the Federal Reserve has been steadily raising short-term interest rates. This tends to squeeze the spread between a financial intermediary's cost of money and what it can earn from putting the money back out to work.
"As much as the financial world may like to blame the Fed, it's not the only reason the group has struggled," said Brad Sorenson, an analyst at Charles Schwab & Co. Until very recently at least, "there's been a complacency toward risk in the marketplace, reflected in corporate credit spreads that have narrowed over the past two years. During this period, financial institutions chased yields and lowered credit standards."
Regulatory controversies of one kind or another have jolted the shares of several big financial companies. According to Bloomberg, mortgage giant Fannie Mae is down 24 percent from Jan. 1; its cousin Freddie Mac, 16.8 percent; and American International Group Inc., 20.6 percent.
The three rank among the 12 largest components of the MSCI USA Financials Index, together accounting for about 10 percent of its value.
Bank, broker, insurance and other financial stocks also make up the largest of the industry groups in the broad Standard & Poor's 500-stock index. As of April 30, financials accounted for 21.3 percent of the index, eclipsing their three nearest counterparts, health care at 13.4 percent, and consumer discretionary and technology at 13.2 percent each.
What's the stigma in that? Well, it conjures up images of excessive popularity, in the manner of energy stocks in the early 1980s and technology in the late 1990s.
With all that, the long-term case for financial stocks is far from dead. Given the inexorable advance of baby boomers born after World War II toward their 60th birthdays, prospective demand for money management and other financial services looks potent for years to come.
Another powerful force is the spread and growth of capitalism around the globe. According to Investment Company Institute data, worldwide assets of mutual funds grew to $16.1 trillion at the end of 2004.
With U.S. fund assets at $8.1 trillion as of Dec. 31, 2004, by my math almost half the world's mutual fund money is now outside the United States -- and that percentage is up 6 points in the past two years.
By traditional basic measures of value, financial stocks look pretty cheap. As of mid-May, the price-to-earnings ratio of the MSCI USA Financial Index stood at 13.4, against 18.9 for the S&P 500. The financial index's dividend yield was 2.8 percent, compared with 2.1 percent for the S&P 500.
At one well-known value-minded fund, the $661 million Tweedy Browne American Value Fund, financials such as American Express Co., Freddie Mac and PNC Financial Services Group Inc. accounted for more than half the fund's stock holdings at last report.
Among the big issues of the day -- U.S. budget and trade deficits, for starters, as well as potential risks in speculative investment markets and financial derivatives -- many people point to credit as the great concern. In a credit crisis, many financial companies will be right in the line of fire.
But there's another way to look at this. If financial companies don't prosper in the long run, how well can anybody else fare? The system is deeply reliant upon them.
Financial stocks can be mercurial. In the credit crunch of 1990, Bloomberg data show that a representative portfolio I selected for its longevity, the Fidelity Select Banking Fund, fell 35 percent in 10 months. That tripled the loss suffered by the S&P 500.
Note also that since the end of October 1990, that same Fidelity fund has averaged a 20.4 percent annual return, trouncing the S&P 500's 11.9 percent annual gain. In any investment plan for growth, it may also be risky to leave financials out.
