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.
