Thursday, July 28, 2011

Don't Bank On It

Investment strategist Richard Bernstein had a column in yesterday's Financial Times talking about global bank stocks.

Bank stocks have been poor performers over the last few months, and their valuations would appear to be very enticing. However, it could also be that we are seeing a major shift in the way that multinational financial companies are viewed by regulators, which could lead a significant crimp in earnings.

Here's an excerpt from Mr. Bernstein's column:

Our research suggests that analysts’ earnings projections for the US’s leading financial institutions may be overly optimistic if we are correct in thinking Washington is increasing its vigilance against global risk-taking. The average consensus long-term earnings growth forecast for the US’s global financial firms is 10 per cent. We feel a more realistic long-term growth rate might be about 6-8 per cent a year.

This is significant for valuation, implying that bank stocks should be revalued downward by 10-15 per cent. It is hard to envision the leading financial stocks outperforming for any length of time when secular growth expectations have yet to adjust fully to a post-credit bubble reality.

Then, in this morning's New York Times, Jesse Eisinger writes that it actually make more sense for the big banks to be broken up rather than let them continue to limp along.

He cites Citigroup and Bank of America as being particularly poor performers, and suggests that both companies would probably benefit from simply splitting into different companies.

For example, writing about Bank of America:

Bank of America’s recent quarterly earnings were so weak that investors and commentators wondered whether the bank should sell off Merrill Lynch, the investment bank for which it foolishly overpaid at the height of the crisis. Bank of America trades at half of its book value (the stated value of its assets minus its liabilities), an indication that investors view its asset quality and prospects just a notch below abominable, as Jonathan Weil of Bloomberg News pointed out last week.

And as for Citi, Mr. Eisinger writes that its stock, earnings and revenue growth has lagged for a decade.

We have not had much bank stock representation in client portfolios for some time now. Our concerns have largely centered on loan growth, which remains anemic for nearly all banks. But the points raised by Messrs. Bernstein and Eisinger makes us even more convinced that largely avoiding bank stocks for the time being is the correct decison.