Financial Stocks.
I added to positions in financial ETFs this week. In some cases these were initiations of new positions. I will have more to buy if these ETFs pull back in price. What I purchased varied depending upon individual client mandates, account size and our different investment strategies. We have been underweight in financials relative to the S&P 500 much of the past several years in most accounts. We are still underweight but less so now.
I thought I would take you through a quick briefing of my investment analysis. Think of this more as an outline. Time and space conspire against me giving a complete report on everything that went into this analysis. Treat this as an illustration of my investment disciplines as I use this same process on everything I either want to buy or currently own for clients. I will do so using the four prongs of our investment discipline: Market Situation, Fundamental Analysis, Valuation and Money Flow Analysis. I will finish with a brief discussion of risk and how I intend to manage this trade.
Market Situation: The overall market climate must drive all of our investment thinking. The playbook tells us that nearly 70% of a stock or ETF's price movement is dependant on what the overall market does. Even though it wouldn't surprise me if stocks flop around a bit here or give up some of their gains, for a variety of reasons I am constructive on stocks going into the end of the year and also for next year. You can see much of my reasoning for this here and here.
Fundamental Analysis: Banks have been in the dog house for almost two years, suffering a near death experience between 2007-2009. Right now the banking business is not great. There is little loan demand and what demand is out there often doesn't qualify for a loan. In addition banks are burdened with billions of dollars of non-performing loans and mortgages. The FDIC continues to seize banks with inadequate assets.
I believe that much of this is priced into these stocks. First the banking survivors have been working through their problems over the past two years and have in many cases raised sufficient capital so that now their balance sheets are less of an issue. The Federal Reserves announced next round of quantitative easing should be a plus for banks and last week's elections suggests that some of the more onerous regulations on the industry overall may at least be scaled back. In addition many banks have deleted or significantly cut their dividends over the past few years. A better economy would likely mean a pickup in dividend growth. Bank earnings have also by and large exceeded expectations in the past several quarters.
I believe that much of this is priced into these stocks. First the banking survivors have been working through their problems over the past two years and have in many cases raised sufficient capital so that now their balance sheets are less of an issue. The Federal Reserves announced next round of quantitative easing should be a plus for banks and last week's elections suggests that some of the more onerous regulations on the industry overall may at least be scaled back. In addition many banks have deleted or significantly cut their dividends over the past few years. A better economy would likely mean a pickup in dividend growth. Bank earnings have also by and large exceeded expectations in the past several quarters.
Valuation: Until recently banks have largely underperformed this year's stock market rally. Even with their recent post election advances banks in aggregate seem to be potentially 15-20% undervalued. If this turns out to be the case then an ETF such as the Spyder KBW Bank ETF {KBE-pictured above} is 4-5 points undervalued as of today's trade. Of course gains have to be measured vs risk. Looking at the chart of KBE {again pictured above-you can double click on it to make it larger} shows downside potential risk of about about 7% based on last summer's price bottom. This is a favorable risk/reward calculation by the playbook for this kind of ETF.
Money Flow Analysis: Much of our reasoning here is pictured in the chart above. I would like to highlight the one point which is that the intermediate and longer term statistics we follow regarding over bought and over sold have recently flipped to positive. These longer term signals have a very high probability of indicating positive price movement in the weeks and months ahead. They are not 100% of course. However, their longer term ratings are such that we feel comfortable entering securities on these signals, especially when the economy and overall market signals are positive.
Risks and managing the trade: Of course there is nothing in this analysis that prevents it from being wrong. Risks to this investment are among other things an overall change in market sentiment, a further deterioration in the economy, and more government involvement in the banking industry than we think is likely. Through the playbook we have formulated a game plan for this security so that we have an idea of what we would do should our analysis prove to be incorrect.
What we hope to do through our disciplines is to identify attractive investments with a higher probability of being correct in both our analysis and price movement. We are as usual purchasing ETFs for financial exposure, hoping to mitigate security-specific stock risk. We also hope that our systems and disciplines enable us to exit a investment thesis with as little portfolio damage as possible should we prove to be wrong.
Since this is a newer purchase (in terms of time when we have added to positions), we'll follow this periodically on the blog to see how we've done.
*Long ETFs related to financial securities in client accounts. In specific, long XLF in client and personal accounts. Long KBE in client accounts. In addition various clients of Lumen Capital Management hold securities of individual stocks in their accounts.
Disclaimer: Any information presented above is given as an example of portfolio discipline and approach by Mr. English for his clients at Lumen Capital Management, LLC. As such this should not be seen as a blanket recommendation to purchase this or any other security mentioned in this article. Nor should it be seen as an endorsement of any investment style or any sort of guarantee of future performance of any security mentioned in this article. Casual readers of this blog need to do their own investment homework or need to discuss the examples expressed in this article with their own financial advisers first. Or better yet, hire us and we'll show you how it's done!!!
Money Flow Analysis: Much of our reasoning here is pictured in the chart above. I would like to highlight the one point which is that the intermediate and longer term statistics we follow regarding over bought and over sold have recently flipped to positive. These longer term signals have a very high probability of indicating positive price movement in the weeks and months ahead. They are not 100% of course. However, their longer term ratings are such that we feel comfortable entering securities on these signals, especially when the economy and overall market signals are positive.
Risks and managing the trade: Of course there is nothing in this analysis that prevents it from being wrong. Risks to this investment are among other things an overall change in market sentiment, a further deterioration in the economy, and more government involvement in the banking industry than we think is likely. Through the playbook we have formulated a game plan for this security so that we have an idea of what we would do should our analysis prove to be incorrect.
What we hope to do through our disciplines is to identify attractive investments with a higher probability of being correct in both our analysis and price movement. We are as usual purchasing ETFs for financial exposure, hoping to mitigate security-specific stock risk. We also hope that our systems and disciplines enable us to exit a investment thesis with as little portfolio damage as possible should we prove to be wrong.
Since this is a newer purchase (in terms of time when we have added to positions), we'll follow this periodically on the blog to see how we've done.
*Long ETFs related to financial securities in client accounts. In specific, long XLF in client and personal accounts. Long KBE in client accounts. In addition various clients of Lumen Capital Management hold securities of individual stocks in their accounts.
Disclaimer: Any information presented above is given as an example of portfolio discipline and approach by Mr. English for his clients at Lumen Capital Management, LLC. As such this should not be seen as a blanket recommendation to purchase this or any other security mentioned in this article. Nor should it be seen as an endorsement of any investment style or any sort of guarantee of future performance of any security mentioned in this article. Casual readers of this blog need to do their own investment homework or need to discuss the examples expressed in this article with their own financial advisers first. Or better yet, hire us and we'll show you how it's done!!!
posted by CR English at 6:18 AM
<< Home