The Big Picture for the Week of November 28, 2010

Pragmatic Capitalism reposted a list of ten reasons why US banks are better to buy than European banks which was originated at Credit Suisse. You should click through to read the list. The logic of the list might be completely correct drawing the correct conclusion; US banks may indeed be better to buy than European banks.

That said, they could both stink and be undeserving of your investment dollars. If you have been reading this site for a while you know that this has been my opinion for a long time now; they both stink and that one group might collectively stink less is not much of a hook for me.

The notion of sovereign contagion should be plausible from Asia 12 years ago and what has happened thus far in Europe. Of course there might not be any further dominoes to fall which leaves banks that operate in markets facing declining real estate prices, over indebted consumers, lousy demographics and weak (at best) growth prospects. From where I sit it doesn’t look much different for the US banks in terms of where we are right now and what appears to lie ahead fundamentally, even if there are many trading opportunities along the way.

I was able to find three financial sector ETFs that exclude the US and Europe (if there are others please leave a comment as it would be easy to overlook something given how many funds there are). There is the iShares Far East Financial Fund (FEFN) which is 59% Japan. There is the iShares Emerging Markets Financial Fund (EMFN) which is promising but has 28% in Chinese financials which I want no part of for reasons I have said many times before. There is also the EG Shares Emerging Markets Financials Titans ETF (EFN) which is 40% in China. A fourth possibility requires going a little narrower with the Global X Brazil Financial Sector ETF (BRAF). I am not a fan of Brazilian financials and have no exposure but I think they have better prospects than Chinese financials.

For several years already and going into the future, in my opinion alpha can be generated in this sector by simply avoiding domestic and European banks and I also do not want Japanese or Chinese financials.

A perfectly valid way to build financial sector exposure, although I prefer individual stocks here, is to capture it via country funds. I’ve disclosed many times being partial to banks from Canada, Chile and Australia. The respective country funds have plenty of financial exposure but if, for example, you are going to buy iShares Australia (EWA) you need to know a little bit about BHP Billiton (BHP) which is the largest holding in the fund. A few clients own EWA as do I. There are plenty of of other country funds that are very heavy in financials like iShares Singapore (EWS) and the Global X Nordic 30 (GXF) which are 50% and 28% in financials respectively and there are more still.

I don’t think this actually requires any less work however. The Market Vectors Egypt ETF (EGPT) is 46% financials. Egypt has some good things going for it to be sure but would you buy the fund not knowing anything about the Egyptian banking or financial system? Hopefully your answer would be no.

Additionally, in using country funds, heed must be paid to the cumulative exposure to all the sectors. You may not have a problem with being 30% financials (way too much for me) but you should know that, or some other number, is your weighting.

The picture is the Astoria, OR branch of Bank of America, at least it was 16 months ago.

7 Comments

  1. Roger and RW,
    at the end of the prev cycle(2002-2007) it was bad to owen banks and finacials since they got creamed more than the rest of the market. Some do not even exist today. At the beg of this cycle it was great owening financials(2009/03 – ?????). In your prespective when is a good time to start owing financials and banks and when should one liquidate all fin. and banks from a portfolio.
    tx,
    Jeff from Milan, Italy

    Reply
  2. this whole post is about seeking financials that have good fundamentals and there are plenty right now outside the US and Europe. Generally the fundamentals of banks in US and Europe stink, they w/b be a buy when the fundamentals don’t stink. Obviously my context is investing not trading.

    Reply
  3. Roger,

    How do you determine if Canada and Aussie banks are not too levered up, or too tied to housing?

    There have been any number of articles talking about rising house prices/bubbles in those countries.

    Thanks!

    Reply
  4. Roger,
    thanks for the answer. Fundementally the foreign, chili, Canada, Austr., middle east fin. look ok. My question is more of a bus. cycle question. It seems to me that the banks have too much to loose at the end of each cycle since the down turn leaves the too expose. However, I have noticed that after an initial rally from back march 2009 they have come down so much and have lost much. I bought MS at 26 and blew out at 29. Big trade of corse. I could not beleive it went to 35. Now they are at 24. I know ms has lots of exposure in US and Japan and if something turns sour they will catch a big cold. I am trying tio put it into right frame were do the banks fit in a bus.cycle and in a stock market cycle.
    Perhaps RW can shed a better light into this.
    Jeff from Milan, Italy

    Reply
  5. Roger, OT question. I was researching utility ETF’s and noticed that the spdr XLU had a tracking error of 12% listed. Was this a typo, or is there a reason for a boring sector like utilities to stray that far from an index? I looked at the holdings, and they were pretty much the same as everyone else’s utility ETF.
    Thanks, and Have a Great Holiday Season,
    Sam

    Reply
  6. 9:52, getting things like capital ratios and knowing that there are no subprime loans in Australia is easy. Australia does have issues with how quickly prices have gone up and affordability. contrast that with a low unemployment rate and a healthy GDP growth makes any potentially negative outcome less severe than the US imo. However Australia has been a source of concern on these points and I can’t rule out chnaging that exposure at some point soon (staying in the country jsut in a different sector).

    Jeff banks are not very cyclical like other sectors but I would not base any decision on past normal cyclicality as the fallout could go on for years.

    Sam, I am sorry I do not know why XLU has that issue. If you own it or are thinking of buying then I would suggest calling them to find out and keep at it until you get an answer that makes sense…and if you’d be willing to share what they tell you here it would be much appreciated.

    Reply
  7. This is one of the questions that either requires a long answer or a short one and since this is a blog comment [g] …Focusing on country is a valid approach to stock selection but that implies an analysis of regional environment and that can tell you a lot about subsectors as well as sectors.

    The series of credit crashes since 1999 have made the business cycle very messy but if this were a more normal recovery I would say financials should be coming online. Since things are not really normal in my view and further shocks could come at any time (agree completely with Roger here, fallout for years) I have no interest in money center or regional banks with wide RE exposure; wouldn’t surprise me if most of them were technically bankrupt frankly.

    But that means we have a (weak) recovery but loan activity is tight and small to medium businesses w/o big cash hordes are having trouble acquiring credit. This improves the environment for alternate funding sources such as business development companies (BDC’s). These have already had a good run up so I wouldn’t expect a lot of growth now but they do have good yields that tend to be stable during an expansion even if the expansion is very modest (which is the best I expect from this one).

    I’ve invested in the subsector for some years, usually in non-controlling firms, because BDC’s were always more regulated and transparent than private equity or venture capital firms and a good source of equity income to add to my bond mix. Added another BDC in Spring of ’08 after the sector got smashed because the numbers suggested it could survive and they didn’t lie.

    These days I would argue BDC’s are also more transparent than banks so it’s really one of the few remaining financial subsectors I feel I can trust the numbers. FWIW

    Reply

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The Big Picture for the Week of November 28, 2010

Pragmatic Capitalism reposted a list of ten reasons why US banks are better to buy than European banks which was originated at Credit Suisse. You should click through to read the list. The logic of the list might be completely correct drawing the correct conclusion; US banks may indeed be better to buy than European banks.

That said, they could both stink and be undeserving of your investment dollars. If you have been reading this site for a while you know that this has been my opinion for a long time now; they both stink and that one group might collectively stink less is not much of a hook for me.

The notion of sovereign contagion should be plausible from Asia 12 years ago and what has happened thus far in Europe. Of course there might not be any further dominoes to fall which leaves banks that operate in markets facing declining real estate prices, over indebted consumers, lousy demographics and weak (at best) growth prospects. From where I sit it doesn’t look much different for the US banks in terms of where we are right now and what appears to lie ahead fundamentally, even if there are many trading opportunities along the way.

I was able to find three financial sector ETFs that exclude the US and Europe (if there are others please leave a comment as it would be easy to overlook something given how many funds there are). There is the iShares Far East Financial Fund (FEFN) which is 59% Japan. There is the iShares Emerging Markets Financial Fund (EMFN) which is promising but has 28% in Chinese financials which I want no part of for reasons I have said many times before. There is also the EG Shares Emerging Markets Financials Titans ETF (EFN) which is 40% in China. A fourth possibility requires going a little narrower with the Global X Brazil Financial Sector ETF (BRAF). I am not a fan of Brazilian financials and have no exposure but I think they have better prospects than Chinese financials.

For several years already and going into the future, in my opinion alpha can be generated in this sector by simply avoiding domestic and European banks and I also do not want Japanese or Chinese financials.

A perfectly valid way to build financial sector exposure, although I prefer individual stocks here, is to capture it via country funds. I’ve disclosed many times being partial to banks from Canada, Chile and Australia. The respective country funds have plenty of financial exposure but if, for example, you are going to buy iShares Australia (EWA) you need to know a little bit about BHP Billiton (BHP) which is the largest holding in the fund. A few clients own EWA as do I. There are plenty of of other country funds that are very heavy in financials like iShares Singapore (EWS) and the Global X Nordic 30 (GXF) which are 50% and 28% in financials respectively and there are more still.

I don’t think this actually requires any less work however. The Market Vectors Egypt ETF (EGPT) is 46% financials. Egypt has some good things going for it to be sure but would you buy the fund not knowing anything about the Egyptian banking or financial system? Hopefully your answer would be no.

Additionally, in using country funds, heed must be paid to the cumulative exposure to all the sectors. You may not have a problem with being 30% financials (way too much for me) but you should know that, or some other number, is your weighting.

The picture is the Astoria, OR branch of Bank of America, at least it was 16 months ago.

Submit a Comment

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