financial stocks have all run down
presents a great
purchase these stocks at low prices and
cheap valuations. What most investors are
sceptical about is their timing in purchasing these shares.
would not have expected the bursting of Americas massive
property bubble to spiral into the crisis and possible recession
that America, the worlds largest economy, is currently
experiencing. The subprime fiasco is just the tip of a much
larger iceberg in a country like America where citizens
have been on the biggest spending binge in the modern history
of the global economy.
The subprime crisis severely affected the US markets which
sent up red flags to the rest of the world. The full extent
of losses from the subprime fallout is still unknown while
new disclosures are being reported almost daily.
The financial sector has inevitably been severely affected
by this crisis which includes firms in the banking industry,
brokers & asset managers, insurance, mortgage, and the
specialty finance industries. The extent of these damages,
Citibank, Merrill Lynch, HSBC, and UBS have all been in
the headlines for writing off billion dollar losses. Major
banks and other financial institutions around the world
have reported losses of approximately US$140 billion as
of February 2008.
In an attempt to cover some losses, these companies have
also been cutting jobs. UBS was forced to announce a 1,500
job cut in October 2007, which was followed by a write down
of US subprime mortgage investments by $10 billion, the
biggest loss by a European bank.
In October 2007, Merrill Lynch & Co reported the biggest
quarterly loss in its 93-year history as a result of their
$8.4 billion of write downs which was almost double what
the firm forecast three weeks before.
These financial companies have been receiving capital injections
from foreign sources which have given hope to investors
and the market.
In an attempt to replenish capital after record mortgage
losses wiped out almost half its market value, Abu Dhabi
injected a cash infusion into Citigroup, the largest US
bank by assets. Abu Dhabi bought preferred shares that convert
to stock and yield 11 per cent a year, almost double the
interest Citigroup offered bond investors. In addition to
Citigroup (to name a few), Morgan Stanley, Merrill Lynch,
and MBIA are also receiving capital infusions from outside
Diagram 1 shows the performance of the financial sector
in comparison with the industry. As can be seen, from September
to December 2007, the financial sector performed worse than
the market. From late December 2007 to February 2008 the
S&P 500 experienced a greater fall than the financial
index due to the performance of the other sectors which
would have weighed down the performance of the market.
The performance of the financial sector, year to date, has
been down 7.45 per cent (as of February 22,) while the market
as a whole, was down 7.85 per cent. It can be deduced that
a large portion of the S&P500 performance is as a result
of the poor performance of the S&P financials.
Lets take a more in-depth look at the performance
of the individual stocks in this particular sector.
For the year, UBS has experienced a fall in the share price
to $33.65, bringing year-to-date returns of -26.85 per cent.
Goldman Sachs and Morgan Stanley both have negative year-to-date
returns of approximately 17 per cent and 16 per cent respectively
with their valuations at $177.71 and $ 44.19 per share.
Among others, Citigroup, HSBC, Wachovia, and Merrill Lynch
also experienced devaluations in their share prices as summarised
in Table 1. However, Bank of America, US Bancorp and Wells
Fargo have managed to maintain positive returns ranging
from three to five per cent with share prices of $42.60,
$32.91 and $31.44 respectively.
Currently, the markets are experiencing extreme volatility,
reacting significantly to the slightest news reports, earnings
releases and economic data which are reported daily. This
will continue to happen for some time, which is causing
investors to remain in their confidence level.
As can be seen in Table 2, the PE multiple of the S&P
Financial Index is currently at 14.9 with an average 5-year
PE of 13.8. It is estimated that at the end of the year,
the PE is expected to be 11.15 while next years estimate
is at 10.53 times. The S&P 500 carries a PE of 18.23
as compared with a 5 year PE of 20.7. The PE for 2008 is
estimated to reach 13.74 for the S&P 500 while next
years PE is projected to be slightly lower at 11.46
times which shows there is still room for further devaluations
between 2008 and 2009.
The million dollar question we are all asking is: have we
reached the bottom as yet? The financial stocks have all
run down significantly which presents a great opportunity
to purchase these stocks at low prices and cheap valuations.
What most investors are sceptical about is their timing
in purchasing these shares.
Have these stocks hit bottom or are they due for further
falls tomorrow or the day after? If investors were to purchase
finance sector shares now, they must be willing to hold
these shares for the long term in order to experience positive
returns, and not sell them as soon as the market begins
to experience a bit of volatility.
As more and more banks are reporting their quarterly results
and earnings, investors are looking on in dismay as they
continue to see ongoing write-downs. However, the bad news
will eventually come to an end and the markets will begin
to make a turnaround. This can prove profitable for long
term investors who purchased their shares when the market
Investors who have already taken a hit from the financial
sector can take the opportunity to average down their losses
by purchasing more of these shares (which would currently
be valued at a lower price to the price at which they were
purchased) in an attempt to decrease their exposure to losses.
For example, if you purchased 100 UBS shares at $46 at the
beginning of the year, you would have an unrealised loss
of approximately $29,000 as at February 21. If, however,
you purchase 100 more UBS shares at the current price of
$32.68 and in the long run the price increases to $45, you
would have a net profit of $1,132 as compared with a net
loss of $100 which you would have incurred if you didnt
purchase the extra 100 shares at the undervalued price.
Much has been written on the roots of the mortgage debacle
but clearly the US consumer's insatiable appetite for debt,
the unfortunate reversal of house prices and rising short-term
interest rates have created the perfect storm.
Banks have already taken corrective action to ensure this
crisis does not dig itself into a deeper hole. They are
now tightening their policies and screening processes where
student loans and car loans are becoming much harder to
obtain. America is slowly learning from its mistakes and
will eventually pull itself out of this dip in the economy.
During the 1990 savings and loan crisis and the long-term
capital crisis of 1998, equities fell below 50 per cent
and 32 per cent respectively.
Investors who purchased stocks at this level would have
gained 50 per cent returns in the following two years.
As the saying goes, History has a tendency of repeating
itself. Hopefully, we all have learnt from the past
and the corrective actions that are being taken to amend
the situation will prove effective.E-mail us at [email protected]
or phone 623-0415/0416 /9360