Since 12 March 2003, the FTSE World Financials Index has risen by 28.2%, well ahead of the FTSE Worl...
Since 12 March 2003, the FTSE World Financials Index has risen by 28.2%, well ahead of the FTSE World Index return of 21.4%. In this context, it is all too easy to forget the problems faced by many financials earlier in the year: dwindling fee-based income for investment banks, falling earnings for asset managers as assets under management dropped and forced selling of equities by life insurers.
Many financials stocks were at a point of extreme distress only a few months ago but have seen their fortunes transformed.
It is interesting how quickly vice can turn to virtue. Having been one of the worst performing areas of the market in the first quarter of 2003, financials benefited hugely in the rally of the second quarter. The quick end to the war in Iraq enabled elevated levels of short term risk aversion to ease back, providing a much-needed catalyst for equity markets.
In turn, higher asset values and a greater incidence of corporate activity have boosted revenues and relieved sectors like fund managers, insurers and investment banks of some of the pressures placed upon them earlier in the year. Above all, it is the expectation that the turn in stock markets heralds a sustained upturn that is driving optimism.
It is not simply by chance that financials, which account for around a quarter of the world index, have seen renewed investor interest. Significant self help has also been applied, increasing company gearing to a potential upturn. Recent quarterly results from the likes of Citigroup, Bank of America and Merrill Lynch illustrate this point clearly.
Much needed operational and financial restructuring in the sector has been greatly in evidence in recent months, with job losses, management changes and share placements the most prominent examples of this phenomena. Merrill Lynch, for example, has cut a quarter of its head count in the past two years.
There is undoubtedly further to go in this field, as attested recently by the scale of the redundancies at one of our smaller rivals towards the end of the second quarter.
There is unlikely to be a straightforward upward climb for the overall financials sector. This is a highly volatile, cyclical industry that relies on the fortunes of financial markets. Any equity or bond market upsets can inflict severe pain for some financial companies.
A sell-off in bond markets, for instance, would impact investment banks that have expanded their fixed income operations over the past few years and profited from the growth in this area.
Furthermore, companies will need to meet or beat expectations during the second and third quarter reporting seasons to maintain the momentum that has been created in the past few months.
However, in mitigation, valuations are in many cases undemanding and there is scope for earnings upgrades if we are correct in our assumption of improving business conditions.
Long term above average growth.
Cyclical sub-sectors beneficiaries of upturn.
Valuations are modest with scope for upgrades.
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