J.P. Morgan (JPM) has published its outlook for 2012 on US financials. Below, we share its comments and discuss its top picks.
Asset Managers, Brokers and Exchanges:
The equity market conditions have remained uncertain and this added volatility will be a hurdle for 2012 earnings for asset managers. J.P. Morgan forecasts that valuations will likely recover if fundamentals improve. Therefore, it is advised to invest in asset managers which are cheaper and can show top-line growth. Exchanges, on the other hand, have seen top volume levels but for 2012 lower volumes are expected. We will not see consolidation in this sector.
Invesco Ltd. (IVZ) is the top pick in this sector due to an improvement in the fund’s performance and a potential for added distribution to drive incremental sales. With a recent merger and acquisition under its belt, Invesco seeks to have sales growth. Currently, its share price is at $20.67 and is expected to go north of $27. It has a market capitalization of $9.3 billion and earnings per share of $1.50.
Franklin Resources (BEN) has been nominated as the worst performing company by J.P. Morgan due to consistent underperformance, and creates a short selling opportunity for investors. The Global Bond fund is expected to have flat sales and, coupled with a recession in the global income fund sales, could end up giving net outflows. Its current price per share of $100.52 is expected to go south of $88 so a short-term sell is advised on the stock.
Large Cap Banks:
The upcoming year does not look to be beneficial for banks due to a slow recovery in the U.S. and an economic recession in Europe. 2012, being an election year, will pose risks for banks. Though, recovery of loan growth and improvements in credit costs will help increase earnings. This will aid in getting rid of the interest margin pressure. Divestitures of U.S. assets by European banks will be of advantage to banks. The biggest problems with slow growth are the state of the U.S. economy, the eurozone and the political risk. US Bancorp (USB) and Wells Fargo (WFC) have the lowest risk due to positive capital returns along with portfolio acquisitions and expansions.
Citigroup (C) has been picked as the best stock for 2012 in the large cap banks. Being a part of the emerging markets, it is expected to recover rapidly. In spite of the harsh stress test, Citigroup may be authorized to return some capital. Currently, it has the largest capital ratios in the industry. Eurozone may still pressurize the stock although revenue and profitability have continued to grow. Citigroup has taken steps to minimize losses and improve risk management. Currently, its stock is trading at $26 and may go north of $51. It has a market capitalization of $86.98 billion and earnings per share of $3.68. Bill Ackman is extremely bullish about Citigroup. He had nearly $700 million invested in the stock at the end of September.
Small and Mid Cap Banks:
Eurozone continues to be a source of risk even for mid and small capitalization banks, but J.P. Morgan predicts a 15% upside in 2012. Although the euro debt crisis does not directly affect these banks, a sudden flight to U.S. Treasuries has ended up in a flatter yield curve which, added to other problems, has had a detrimental effect on net interest margins. These mid- and small-cap banks are also buying back their stock at historical lows which will prove to be beneficial for them.
First Horizon (FHN) is valued by J.P. Morgan as an attractive stock for the first time. This is due, in part, to inexpensive valuation and improvements in the credit. A $100mm buyback plan was announced in the third quarter of 2011, giving positive signals to investors. First Horizon’s stock is currently trading at $7.43 and is expected to remain between $5.38 and $12.67. It has a market capitalization of $1.96 billion and earnings per share of $0.14.
The life insurance sector has a positive outlook for the year 2012. Despite the adverse environment, J.P. Morgan expects this sector to generate a greater than 10% ROE.
Repurchasing of shares and raising dividends will be the plan for most companies with excess capital. With the rise in capital levels over the years, the investment portfolio risk is easier to handle due to the reduced exposure to structured securities. Also, insurers are now backed by better hedging programs. Sales of annuities are expected to increase, while interest rates have sustained at low levels.
Prudential Financial (PRU) has been nominated as the best stock in this market segment as the projected returns are expected to grow over the coming years. ROE and EPS are forecast to increase every year due to an organic growth, capital deployment, and accretion from the Star/Edison acquisition. Its stock is currently trading at $51.41 per share and is expected to go north of $67. With a market capitalization of $24.99 billion, Prudential has earnings per share of $6.90. Diamond Hill Capital is the most bullish hedge fund about Prudential. It had $126 million invested in PRU at the end of September.
The bottomed pricing of 2011 is showing signs of improvement in a few market segments. Despite being a positive sign, these prices need to rise further in order to be beneficial for this market segment. Due to the absence of market catalysts, J.P. Morgan is not convinced that this industry is following a traditional cycle turn. Actually, it seems that underwriters are responsible for increments in prices. Although pricing trends have remained positive, it is not substantial enough to give this sector an overweight rating.
Allstate Corporation (ALL) is the second largest personal lines insurer in the U.S. It is a top pick as it gives investors the best risk-reward opportunity in its sector. It will also produce bottom-line growth in the upcoming years, being one of the few to do so. Currently, its stock is trading at $27.12 per share and is expected to go north of $34. It has a market capitalization of $13.7 billion and has earnings per share of $2.84.
REITs/Real Estate Services:
In 2012, REIT stocks will have double digit returns close to mid-teens. An increase in market rents and occupancy is expected for REIT portfolios in 2012. The balance sheets of most REIT buyers have been better than most of their peers in the private market.
Public Storage (PSA) is the top pick in REITS for 2012 due to its relative valuation. It trades at 22x the 2012 AFFO estimate by J.P. Morgan and has a competitive dividend yield. Its shares are currently trading at $129.12 per share and are forecast to trade at $132.20. It has a market capitalization of $23.1 billion and an FFO of $4.72.
Specialty and Consumer Finance:
J.P. Morgan has forecast a cyclical peak in credit performance. This is likely to benefit few asset classes (consumer, commercial, secured, and unsecured). Loss rates and loan growth rates are expected to remain at an all-time low. To get the best returns, J.P. Morgan suggests that investors need to feel comfortable with tactical entry points.
American Express (AXP) is the best consumer finance stock idea for 2012 because the company is ready for normalized credit and a growth in its portfolio. This is based on J.P. Morgan’s analysis that high-end consumers are not highly prone to cyclical trends. American Express is expected to raise operating leverage for 2012. Currently, its stock is trading at $48.56 per share and is forecast to remain between $41.25 and $53.80 in the upcoming year. American Express has a market capitalization of $56.4 billion and its earnings per share are $3.38. Warren Buffett had nearly $7 billion invested in AXP at the end of September.