Are Financials Now A Value Play? 12% Market Cap Vs. The 20% Earnings Weight

Jun. 28, 2019 12:55 PM ETXLF, FAS, FAZ, VFH, UYG, FNCL, IYF, BTO, IYG, RYF, FXO, SEF, FINU-OLD, RWW, FINZ, JHMF11 Comments7 Likes
Brian Gilmartin, CFA profile picture
Brian Gilmartin, CFA
8.95K Followers

Summary

  • Financial stocks received no boost from last week's stress test results.
  • Financials today represent a 12%-13% market cap within the S&P 500, but have a 20% "earnings weight" within the same benchmark.
  • While the Tech sector remains a substantial weight in client accounts, the Financials offset that "growth or momentum" component to client accounts, and seem to be far more "value" than growth today, with dividend yields and capital return.

Attached is a weekly chart of Schwab (SCHW), clients' 2nd largest holding behind Microsoft (MSFT), and a mutual fund firm with $3.5-$4 trillion in assets under management, assets greater than Goldman Sachs, Morgan Stanley and a host of others.

I was out to dinner a few weeks ago, with friends, one of whom is a senior VP with a well-known Chicago custodian bank, and in the last year his mom had passed and had a couple of accounts at Schwab. This long-time friend noted Schwab's "operational excellence" in his dealings with them, which given his position at a somewhat competitor was telling.

This isn't an advertisement for Schwab (which is this blog's 3rd party custodian, holding all client assets) but I wanted a stock (or chart) that would highlight how the interest-rate sensitive financials have really lagged since early 2018, and in my opinion are now dramatically oversold.

The December '18 low for Schwab was $37.83. That's your line in the sand (so to speak).

Sector PEs - check this chart:

The Bespoke research we get is some of the best research dollars spent for clients.

This "relative PE" chart from the Bespoke crew is from the May 10, 2019, Bespoke Report. It caught my eye at the time given how cheap Financials were (and still are) but with the rate cut probabilities approaching 100% for July '19, can that provide the catalyst for the sector? Lower short-term rates, higher longer rates, and a yield-curve steepening might just be the "macro" that helps the sector.

Financial stocks received no boost from last week's stress test results.

Here is a brief recap of YTD returns of client's major Financial sector holdings:

  • XLF: +9.75%
  • KRE: +7.83%
  • JPM: +12.76%
  • CME: +2.88%
  • SCHW: -3.7%

(Trailing return data courtesy of Morningstar, as of 6/26/19)

S&P 500 sectors "Market Cap vs. Earnings Weight"

Here is another stunning statistic: Financials today represent a 12%-13% market cap within the S&P 500, but have a 20% "earnings weight" within the same benchmark.

Summary/conclusion: While the Tech sector remains a substantial weight in client accounts, the Financials offset that "growth or momentum" component to client accounts, and seem to be far more "value" than growth today, with dividend yields and capital return. That being said, the problem with value investing is that long-term investors have to await the catalyst to trigger the outperformance for the sector. The 18-month lag in performance is getting tough to endure, which is typically the case when something owned for clients lags the S&P 500 badly.

There could be many reasons why Financials are underperforming: the biggest worry for me - and Jerome Powell even commented on it - was Facebook's (FB) Libra currency and what that could mean for the financial system. Needless to say, that could be disruptive to say the least.

But this is value investing. When Joel Greenblatt, the famed author, B-school professor and value investor came to Chicago last December '18 to speak at a CFA luncheon, he noted an amazing stat: Almost 45% of managers with exceptional 10-year track records (upper decile performance) spent at least 3 of those years at the bottom of the rankings (showing patience for the catalyst to arrive, and those are my words, not the Professor's).

If you are long Financials stocks, continue to be patient.

Thanks for reading.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

Brian Gilmartin, CFA profile picture
8.95K Followers
Brian Gilmartin, is a portfolio manager at Trinity Asset Management, a firm he founded in May, 1995, catering to individual investors and institutions that werent getting the attention and service deserved, from larger firms. Brian started in the business as a fixed-income / credit analyst, with a Chicago broker-dealer, and then worked at Stein Roe & Farnham in Chicago, from 1992 - 1995, before striking out on his own and managing equity and balanced accounts for clients. Brian has a BSBA (Finance) from Xavier University, Cincinnati, Ohio, (1982) and an MBA (Finance) from Loyola University, Chicago, January, 1985. The CFA was awarded in 1994. Brian has been fortunate enough to write for the TheStreet.com from 2000 to 2012, and then the WallStreet AllStars from August 2011, to Spring, 2012. Brian also wrote for Minyanville.com, and has been quoted in numerous publications including the Wall Street Journal.
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