So the market has finally gotten off of the double dip talk. While stocks still face many challenges, there is a strong sense that the market has likely bottomed for the year. While the fact that volatility has decreased doesn't necessarily mean the market will continue to move higher, I think the stability in even beat-up sectors like the financials makes these historically cheap stocks worth researching a little more. The financial stocks bottomed around when the market hits its September low of 1060, stocks like Wells Fargo (WFC), Citigroup (C), JP Morgan (JPM), all have share prices that remain at or near their all-time lows.
Investing in the financials has been in unrewarding endeavor for most investors for some time. Not only have these stocks performed the worst during market sell-offs, they have also rebounded only slightly during market bounces and some of the more sustained moves up over the last several months we have seen. Still, despite the horrific trading action in the financials we have seen for some time, now that the likelihood of a major credit event in European or the U.S. has diminished significantly, it's worth asking if there is value to be found in this troubled sector.
What was most interesting to me about the recent earnings reports of the financials was that they finally showed a separation between the more internationally focused business models of Bank of America (BAC) and Citigroup, from the more domestic focused growth strategies of JP Morgan and Wells Fargo. Despite consistent positive commentary by Buffett and others on JP Morgan and Wells Fargo, Citigroup was the only bank that delivered on earnings and showed solid growth in its core businesses. This separation in profitability between the more internationally-focused business models of Citigroup and Bank of America, and the domestic-focused banks like JP Morgan and Wells Fargo appears to be widening now.
To me it is becoming very clear that JP Morgan and Wells Fargo offer little to no current value. While some argue that these are the best run financials in the U.S., these companies continue to get the vast majority of their revenue from the increasingly smaller U.S. debt markets, where a large number of companies are just chasing fewer financial and other business opportunities. The banking sector in the U.S. is heavily saturated and the financials who rely primarily on the domestic economy for growth continue to struggle. Also, since trading revenues have weakened significanlty in recent quarters at the U.S.-centered banks, their business models have continued deteriorate in even new areas over the last couple quarters.
If you look at the earnings reports of the major U.S. financials over the last couple of quarters, the international based banking revenues of Citigroup and Bank of America have been the only real areas that have showed consistent and solid growth. Obviously, though, Citigroup remains the only internationally-focused U.S. financial that has been cleared to pay dividends by the fed and isn't facing any imminent and daunting legal challenges.
Despite failing to get any of the big name CEOs like John Thain or Larry Fink, Citigroups's decision to promote Vikram Pandit internally appears to have worked out very well. Since Pandit was more modest and eager to prove himself worthy of his new title rather than put his own stamp on the company, he acted quicker and more decisively than many of his peers. Citi was much quicker to sell-off assets, write-down CDO exposure and also cooperate with regulators and settle potential lawsuits. Citi also apologized openly to the public for its behavior during the financial crisis and quickly moved to refocus their business model on the best parts of their global banking franchise. Today, when you look at Citi's business model, the company looks like an international bank headquartered in the U.S., since the company gets nearly 70% of its revenue overseas. While other banks fought with regulators and dealt with moderate to severe liability issues, Citi cooperated with its regulators and took swift action to refocus the bank's business model. Today the company is strongly positioned in almost every major emerging market economy with bold plans for continued future growth.
While Bank of America also has a strong global presence in many international financial markets, Citi is the only U.S. financial that has generally enjoyed a good relationship with regulators and has not had the same kind of troubling legal and financial issues. While Jamie Dimon gets all the press over his flamboyant comments about various new regulatory proposals, Citi continues to quietly execute very well across the interntioanl markets it gets most of its revenues from.
In Latin America, for instance, Eduardo Cruz, one of the most respected executives in the banking industry, continues to be highly successfully building out the company's retail and investment banking presence. Also, In Asia, where Citi has its largest international footprint, the company continues to be similarly successful in building out its core banking business across the region, with a particularly strong retail franchise in India.
The only obvious problem with these arguments is that they have been true for nearly a year, and although Citi and other financials have had bounces, they have not been able to hold gains for some time. Given the regulatory uncertainty and other headwinds preventing capital from moving into the financials today, the question is how you can invest in this sector and get a solid return if the stocks take some time to recover. While Citi has had several good earnings reports now, the company's share price continues to remain depressed along with the other financials. Money managers also seem unwilling to commit significant capital to this sector because of the view that the regulatory and economic challenges that this industry faces are simply insurmountable.
The question is how to invest in the financials in a manner that enables you to get take part in the upside move in these equities while still geting a nice return while the share prices of these companies continue to stay weak. Obviously, it is likely that the share prices of the financials may not appreciate significantly for some time. Still, the Citi preferred offers safe returns of 5-6% a year while still giving the investor upside in the companies share price as well. While the tax implications may vary for people in different income brackets, a 5-6% a year yield in a stocks that is likely a moderately-to-significantly undervalued equity with strong future growth opportunities is rare.
To conclude, banking stocks are certainly not a popular investment today. While many good reasons exist to not invest in a number of financials in the U.S. and elsewhere, I still believe that there are good opportunities in this sector. No investment is risk-free, and that is certainly true when investing in the financials. Still, given that Citi has a rock solid balance sheet and the best growth opportunities of any of the U.S.-based financials, this looks like a safe way to invest in a sector that could offer significant long-term returns. Timing the market is hard, but being able to invest in way that offer value and yield with the possibility of moderate to strong future growth prospects is rare.