Financials Driven by Outside Forces

The Financial Sector is getting very attractive from both a fundamental and technical perspective. Definitely looking oversold and undervalued on the surface. Can you really rely on these indicators or is there more to it?

The financial sector has a market capitalization of $1.3 trillion dollars. This represents a little more than 25% of the TSX composite market capitalization of just shy of $4 trillion dollars. The financial sector includes the major commercial banks, diversified financial services and insurance companies. Some of the companies included in this index are AGF Management Ltd. (AGF.B), Bank of Montreal (BMO), Bank of Nova Scotia (BNS), CI Financial Corp. (CIX), Canadian Imperial Bank of Commerce (CM), Canadian Western Bank (CWB), Dundee Corporation (DC.A), and Great West Lifeco (GWO).

Since the high in May 2008, the index has fallen more than 50. On Friday Feb 20, 2009 the financial sector closed at $95.48. The high over the last year was $201.04 reached on May 2, 2008 while the low was $93.55 reached on Friday this year. Since September 2008, the financial sector has been trading in a clearly defined downward channel. From a technical standpoint there are no indicators as to where the bottom is for the financial sector. The highs and lows just keep getting lower.

Fundamentally, the P/E and the dividend yields are very attractive. The average P/E ratio is now 9.92 vs. 10.22 in November 2008 and the dividend yield is now 7.59 vs. 4.93 in November 2008. The only thing I would question is whether the P/E is valid given earnings revisions downward. This is something john Mauldin alludes to in his articles “Outside the Box”. Although it doesn’t appear that their payout ratios are high relative to cash flow, I would also question whether dividends will be cut based on how lofty they are.

In November, I pointed out that seasonally Banks tend to outperform at year-end. The year-end rally never came last year, so seasonality didn’t work and investors are no more desensitized to the bad news than they were last year. The bad news is more a result of worldwide problems in Banking than the Canadian Banks. John Morrissy from the Financial Post wrote on Wednesday, February 18, 2009, “Being the envy of the world--and most Canadians--did not stop Canadian bank shares from sliding to lows not seen in six years as the global financial crisis sent financial stocks reeling worldwide. Weakening corporate earnings and economic data, the stability of banking operations in Eastern Europe, fears of a General Motors bankruptcy filing and doubts about U. S. Treasury Secretary Timothy Geithner's bank rescue plan sent global stock markets sharply lower Tuesday, led by banking issues. The plunge in Canadian financial issues came despite a survey released Tuesday by PricewaterhouseCoopers showing 84 per cent of Canadians believe Canada has one of the strongest banking systems in the world, and praise paid at the recent G-7 meeting by world leaders who have had to rescue their own banks with billions of dollars in taxpayer bailouts.’ Canadians are confident in their banks, and they should be,’ said George Sheen, of the Canadian Financial Services practice at PwC. ‘They are well regulated, well capitalized and well run’”. Despite this, I would wait for at least some sign of technical support before jumping in too early because the financials are driven more by external forces at this time.