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I don't think we should talk about the financial sector anymore.
No, no, I'm not saying we shouldn't talk about bank, insurance, brokerage, asset-management and investment-banking stocks because their performance is so embarrassing, so maddening, so frightening that we should keep them locked out of sight in the attic like the first Mrs. Rochester in "Jane Eyre."
No, my reason is much less gothic. The stock market doesn't have a single financial sector anymore. Instead, the bear market has broken the financial sector into two groups of stocks that behave very differently. And importantly for investors looking to eventually get back into financials in order to rebuild portfolios, these two groups will behave very differently in any post-bear rally.
Group No. 1 will rally strong out of the gate and then fade. Group No. 2 will start slowly but prove to be the horse to ride to long-term gains as the market and the economy recover.
See a strategy there? I do. In this column I'll tell you why I think financial stocks are now divided into two groups, and I'll give you five names that belong to each one.
Group No. 1: Famous but broken
Stocks in this group were household names before the financial crisis hit, and they've made headlines in the past 12 months because they've had to fess up to the worst behavior and the biggest losses.The behavior and the losses have been so bad that these companies have seriously damaged -- for the long term -- franchises that were among the best in the financial industry.
Group No. 2: Survivors ready to pick up the pieces
These companies haven't escaped all the damage in the crisis -- no financial company has -- but the dings and scrapes they've suffered can easily be hammered out. These companies are in good enough shape that they'll be able to pick up the pieces from their more damaged competitors.Why is this grouping important?
Famous but broken stocks move up like rockets when it first looks like the sector's fortunes have turned, as the July and August rally in financials showed. Bank of America (BAC, news, msgs), a classic famous but broken financial stock, climbed 68% from July 15 through Aug. 31, when it looked like the sector might be getting set to lead the whole market higher. The Dow Jones Industrial Average ($INDU) was up an impressive but still much smaller 5% in that month and a half.
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And as the failure of the July-August rally shows, these same stocks stall and then plunge when the market as a whole does. Shares of Bank of America fell 42% from Aug. 31 through Nov. 11. The stocks in this group need a rising tide to lift all boats.
Survivors ready to pick up the pieces hold value better than their more famous but damaged peers. US Bancorp (USB, news, msgs) dropped just 27% from the stock market's Oct. 9, 2007, high through its July 15 low. That seems like a lot until you compare it with the 62% loss that Bank of America delivered during that period.
The stocks in group No. 2 deliver solid if less spectacular gains when investors think the market in general and financial stocks in particular have turned around. US Bancorp gained 40% from July 15 through Aug. 31. That's not Bank of America's 68%, but it's not too shabby. And these stocks suffer less when the overall market drops. From Aug. 31 to Nov. 11, when the Dow industrials fell 24%, US Bancorp shares fell just 17%, less than half as much as Bank of America.
This suggests a two-stage approach to making money in financial stocks once the stock market looks like it has turned for good. (When will that be? Sometime in the last half of 2009 would be my best estimate now.) First, buy some famous but broken stocks for their quick blastoff. Then switch your capital and profits into survivors ready to pick up the pieces for the long stretch run. That's aggressive, I grant you, but aggressive is what we'll have to be in order to make back what the bear market has taken out of our portfolios.
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Is an end-of-year rally ahead?Bah, humbug! The holidays may not be as cheerful as Jim Jubak had hoped. The market rally is still coming, he says, but it will be shorter -- and with smaller gains -- than originally thought.
If you want to be less aggressive, skip group No. 1 entirely and go straight into group No. 2 when the time is right. (For why you must own financial stocks for the long run -- once the bear market is over -- see my May 13 column, "5 financial stocks for the long term.")
OK, now on to my picks:
5 famous but broken financials
- Bank of America can now reach 78% of the U.S. population. That translates into a tremendous $874 billion in customer deposits, a treasure of low-cost capital at a time when raising money in the capital markets is difficult and expensive. In theory, Bank of America can create a lot of revenue by cross-selling products to that huge base of customers. For example, only 10% of the bank's 8 million most affluent customers use its wealth management products. That's one reason the bank recently bought Merrill Lynch (MER, news, msgs). But what Bank of America has done is to recreate the one-stop bank model that has proved so devastating to the health of Citigroup (C, news, msgs). You've got to question whether CEO Ken Lewis -- who said, "No more investment banking, thanks," just months before buying Merrill -- has enough discipline to prevent a rogue division from sinking the ship. That is exactly what happened at American International Group (AIG, news, msgs), after all. B of A's yield is now 6.25%, but the bank is certainly at least thinking about cutting the dividend. Shares fell 64% from Oct. 9, 2007, through Nov. 11 of this year.
- ICICI Bank (IBN, news, msgs) is India's largest private-sector insurance and asset-management company, and owns the largest market share in important consumer loan sectors, such as credit cards. But the bank seems to have suffered a major loss of confidence by customers that has led to persistent rumors about potential insolvency and repeated runs on the bank. ICICI customers apparently have long memories and can recall the bad old days when this bank's predecessor company almost went bust. Customer confidence is critical for a bank that draws a large part of its capital from customer deposits. Shares dropped 69% from Oct. 9, 2007, through Nov. 11.
- ING Groep (ING, news, msgs) was in a great position to pick up the pieces from AIG, Citigroup and the rest, but then the company ran into a loss of confidence that hammered its stock price. The fix was a $13 billion cash infusion from the Dutch government. That now hangs over the stock, since the company has to pay back $19.5 billion or convert the government's money into shares before it can pay out another dividend. I believe conversion is the likely course, which will seriously dilute existing shares. Still, the stock would be worth about $24 a share even with the dilution. But all this turmoil has taken its toll on the company's plans to expand its online banking business in the U.S. and its insurance business in Asia and Latin America. Shares dropped 76% from Oct. 9, 2007, through Nov. 11.
Continued: 2 more broken financials and 5 survivors
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