Financials ETF: The Worst May Be Behind Us

I’ll be the first to admit that we’re not first to press with that storyline. However, one of the lessons we learned (the hard way) during the recent credit crunch is that analysts’ forecasts of earnings estimates can be quite unreliable, especially at inflexion points. For instance, last year consensus estimates for firms in the Financial Select Sector SPDR (XLF) were rising through mid-summer, well after the sub-prime story started unraveling.

So this time around we wanted to wait for actual results, as opposed to relying on analysts’ predictions, to mark a turning point for Financials. Now with about 80% of S&P 500 firms having reported Q1 2008 earnings, it looks as if we can make that claim with some confidence: aggregate profits of firms in XLF will be about $12 billion, down a whopping 79% versus Q1 2007, but nonetheless a big improvement over the previous quarter, Q4 2007, which saw aggregate losses of some $21 billion (Figure 1).

These results include all write-offs announced to-date, and although the level of profits is severely depressed, at least there are profits, implying that the worst of the financial bleeding may be behind us.

Unfortunately, this does not mean Financials enjoy a rosy operating environment. Estimates for the full-year 2008 are still declining rapidly, and we expect quarterly figures for Q2 – Q4 to be reduced further from their current levels. Easy comparisons in the second half of the year—Q3 could show slight growth in earnings once all numbers are in while Q4 will almost certainly be a big improvement over the losses suffered in Q4 2007—may look good, but earnings are nonetheless likely to remain depressed for some time. In fact, current estimates for 2009, for what they’re worth, still envision earnings below those in 2006!

Figure 1: Financial sector quarterly earnings ($bns)

Source: www.etfresearchcenter.com

Despite all this, we have liked XLF for some time due to valuation, but many investors who agreed that stocks in XLF are cheap nonetheless didn’t want to catch a falling knife. Now, with the first quarter’s $34 billion improvement from the prior quarter, there’s good reason to believe that the knife has hit the floor and is now safe to pick up.

Comments

[karchad]

With the financial and housing sectors down so much, if you won't buy now, when exactly will you buy? Wait for them to move up 40%? This article is right on. I'm loading up on distressed sectors. That's how one makes long-term money without guesswork.

[gaucho]

I think that the above commenter should buy all the housing stocks and financial stocks that he can margin. Shake well and wait one year and he will not be around to annoy us any longer.

What many do not get is that the FED is lying about the consumer spending and inflation and the GDP. The rest of the world does not believe these BS numbers and we should not believe them either. Open your eyes and look at what stuff costs!! Buy milk bread eggs gas cars etc. The prices are rising at an accelerating rate. The FED will lie and lie and lie to prop up the economy so the elections will not be a disaster for the incumbents.
The housing foreclosures will accelerate all the way through 09. The oil prices are going to keep rising and the dollars will at best stabilize and most likely fall driving fuel prices up further.
BANKS make money in a healthy economy not a sick one!
These optimists and cheerleaders will cause you to lose all your money if you listen to them.

[venividivici]

Absolutely spot on Gaucho. But you can't save fools from themselves. All you can do is look after yourself.

[Jay]

"These results include all write-offs announced to-date, and although the level of profits is severely depressed, at least there are profits, implying that the worst of the financial bleeding may be behind us."

How does the fact that - after all write-offs announced thus far, some level of profitability remains - indicate that the worst is behind us? Someone please enlighten me?

[Mike Stathis]

The banking mess will take many years to fix. The worst is by no means behind us. Gaucho is correct. See my series of articles to be posted starting tomorrow on how Washington is fooling us with its manipulation of economic data.

If you really are interested in the banks, I suggest you keep a close eye on all of the stock offerings that have been going on, most without much media fanfare. Shareholders are getting diluted down to nothing and this will continue. Just take a look at the recent dilution of WM. So with all of this dilution occuring combined with banks having to sell off their assets, how do you expect earnings to recover anytime soon???

With so much blood in the streets, yet so much more waiting to spill, why get involved in the financials of all things????

Stick with oil, other commodities, foreign currencies, precious metals, and healthcare.