Though the financial sector has been one of the star performers so
far this year, its growth momentum slackened in Q3 with 9.9%
earnings growth. This was in stark contrast to 30% earnings growth
seen in Q2 for financial equities. In fact, excluding
Bank
of America (BAC), the sector’s Q3 earnings growth slipped
to 3.3%.
Results from two industry bellwethers –
J.P.
Morgan (JPM) and
Goldman Sachs (GS) –
were underwhelming. If this was not enough, the credit-rating
organization
Moody’s (MCO) downgraded long-term
senior unsecured debt of four top-tier U.S. banks including Goldman
and J.P. Morgan, to add to the woes.
What’s Behind the Downgrade?
Apart from Goldman and JPM, Moody’s cut its credit rating by a
notch for
Morgan Stanley (MS) and the
Bank
of New York Mellon (BK). As per the agency, the U.S.
government might not be ready to intervene and bail out a stressed
financial institution in any upcoming crisis as it did five years
ago (read: Capital Market ETFs in Focus on Taper Talk).
This is because of the fact that regulatory instructions under the
Dodd-Frank Act are against the taxpayer funded bailouts for
rescuing a failed bank. The Dodd-Frank Wall Street reforms also
limit banks' ability to go for risky investments and urged
institutions to be transparent in financial practices.
In the downgrade, the agency mostly considered the banks’ core
health and ruled out any boost from the government. In such a
scenario, debt holders of the said banks might have to bear the
burden of a credit default in the future.
On a positive note, Moody’s reiterated the senior holding company
ratings of Bank of America,
Citigroup Inc. (C),
State Street Corp. (STT) and
Wells Fargo
& Co. (WFC).
Market Impact
This news led to some modest losses for the concerned companies.
Shares of JPMorgan dipped 0.9% in after-hours trading, Goldman
Sachs lost 0.2% while Morgan Stanley dropped 0.7%, on Moody’s
announcement day.
All the aforementioned companies have considerable exposure in
funds like the
PowerShares KBW Capital
Markets (KBWC),
iShares US Broker-Dealers
(IAI),
iShares U.S. Financial Services ETF (IYG),
and the
PowerShares KBW Bank ETF
(KBWB
).
While KBWC and IAI have 6%–8% exposure in Goldman and Morgan
Stanley, KBWB and IYG put at least 8% assets in JP Morgan (read:
Financial ETFs Tumble on Citigroup Warning).
While we do not believe that only the Moody’s announcement can hit
the above-said financial sector ETFs which have sizeable exposure
in better-rated companies as well, these could be the ones to watch
out for following any unforeseen hit or miss in the financial
sector:
PowerShares KBW Bank Portfolio (KBWB)
This ETF follows the KBW Bank Index and normally invests at least
90% of its total assets constituting the cap weighted index. With
about two dozen financial stocks in its basket, the fund has so far
amassed $168.8 million in assets. The ETF sees decent volume of
about 130,000 shares a day and charges investors 35% of fees to own
the fund.
In terms of holdings, KBWB is headed by Citigroup and Bank of
America while the in-focus JP Morgan takes up the third spot. All
three have over 8.0% of holdings in the fund. Large caps dominate
the fund at roughly 80% of the total assets, while the portfolio
definitely has a value tilt with more than 60% of the fund going to
that type of security.
Following the Moody’s cut on November 14, the fund advanced only
0.14% while KBWB returned a massive 22.98% on a year-to-date basis
(as of September 30, 2013). The fund currently has a Zacks
ETF Rank #2 (Buy) with a Low risk outlook (also read Top Ranked
Financial ETF in Focus: KBWB).
PowerShares KBW Capital Markets (KBWC)
KBWC – a relatively less popular choice in the space – looks to
track the KBW Capital Markets Index. This cap-weighted benchmark
reflects the performance of businesses concerning broker-dealers,
asset managers, trust and custody banks among others in the space.
This fund also has a portfolio of two-dozen stocks and lighter
volume of about 3,500 shares a day, along with AUM of just over
$9.0 million.
Morgan Stanley takes the top spot in terms of assets at 9.4%, while
another in-focus bank, Goldman, assumes the third spot with more
than 7.0% exposure. State Street – a stock with reaffirmed rating –
took the second spot with above 8% weight to round the top three.
The fund charges an expense ratio of 0.35% a year.
In terms of performance, this fund was up about 1.87% in the
trailing three-day period despite the downgrade of two key
elements. In the first nine months of the year, the fund gained
29.4%. KBWC also carries a Zacks ETF Rank #2 with a Medium risk
outlook (see all the Financial ETFs here).
Other Choices
The other two products
IAI and
IYG – both of which are exposed to GS, MS and JPM
– delivered a return of around 0.8% and 0.6% in the concerned
period while in the last one-year period (as of September 30, 2013)
IAI shot up 50.6% and IYG posted an impressive 34.4% return.
Both these iShares funds charge 0.45% in fees per year. While IAI
has a Zacks ETF Rank #2 with Medium risk outlook, IYG has a Zacks
ETF Rank #3 (Hold) with a Low risk outlook.
Bottom Line
The financial sector has lost some luster but is still in demand.
Investors can still count on the sector which is likely to return
to revenue growth next year. Bullish Zacks ETF Ranks for most of
the funds are also supportive of this view.
Moreover, financial institutions which are more into the
broker-dealer/capital markets segment might get their share of aid
next year, if not in December, when the ‘taper talk’ resumes in all
likelihood. Thus, there are clearly plenty of drivers in store for
the sector to make up for the disappointment created by Moody’s
downgrade.
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GOLDMAN SACHS (GS): Free Stock Analysis Report
ISHARS-US BR-D (IAI): ETF Research Reports
ISHARS-US FN SV (IYG): ETF Research Reports
JPMORGAN CHASE (JPM): Free Stock Analysis Report
PWRSH-KBW BP (KBWB): ETF Research Reports
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