Why to be bullish on financials

There’s been some anxiety over the state of the housing market and consumer debt moving higher. But despite these factors, Canada’s banks were still solid investments last year.

“The banks were trading at a discount relative to other interest-sensitive names,” Andrew Marchese, head of Canadian equities, Fidelity Canada said at a roundtable last week.

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As a result, portfolio returns were over 20%. “We saw the banks, from a securities standpoint, were starting to tailor in some risk,” he says. “But the situation continued to be quite benign.”

Moving forward, he’s still bullish, but adds he’ll pay “attention to the credit cycle.”

And the financial sector was strong around the globe.

In the U.S., financials outperformed by about 4% in 2013, says Mike Hickey, institutional portfolio manager, Fidelity Investments.

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“Housing in the U.S. continues to improve. Even though mortgage rates are backed up, the 30-year is trading around 4%, and that’s attractive for consumers.

Consumer credit overall is getting better. Employment continues to improve.”

These factors will push the financials sector even higher in 2014.

Europe’s financial sector is another to consider.

“Even in the face of higher capital requirements, there are businesses that will have higher return on equity, and their valuations are cheaper than the U.S.,” says Jed Weiss, portfolio manager, Fidelity International Growth Fund.

He adds, “Germany and the Nordic [countries] are booming. If you can find economies nearby, their local financials are consolidated and cheaper. Those are potential opportunities.”

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Here’s what else to expect in 2014.

Canada

The amount of money being printed globally poses a real risk to gold, says Marchese. “What you need to see for gold to have another leg up is inflation.”

Meanwhile, he notes supply and demand doesn’t look great for base metals. “There’s a lot of supply coming on board, [especially for] copper, metal and zinc. Securities have some way to go to adequately price that in.”

And despite the tough environment for commodities in 2013, the sector was up 13%. But it may not perform as strongly in 2014. Marchese suggests focusing on the energy sector, particularly oil.

“We’re looking for good companies that have strong management teams and strong reserves in the ground.”

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He adds there are a lot of undiscovered opportunities in Canada. “Investors shouldn’t be so quick to write [it] off.”

U.S.

Down south, 2014 will be a stock picker’s market, says Hickey.

“It was a good market for active managers in 2013, but as we move forward we’d expect most areas in the market to trade up with earnings.”

Technology is one area to be bullish on, especially companies that are based in California’s San Fernando Valley (Los Angeles) or Silicon Valley (San Francisco).

“Those have moved a lot in price appreciation,” says Hickey of social media businesses in particular. “The economics are attractive [and they’re] high cash-flow generators.”

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Healthcare is also strong, thanks to Obamacare making the sector a top newsmaker last year.

“That’s bringing a lot of folks into the healthcare system and should drive demand for products and services as we move through this decade.”

He suggests looking at medical device companies, which can provide long-term, secular portfolio growth.

And in terms of asset allocation, many institutions are still underweight equities and overweight fixed income. Hickey predicts “as the bond market continues to sell off, you’ll see allocation [move] away from fixed income and into U.S. or non-U.S. equities from U.S. investors.”

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However, American investors are still slightly bearish, even though equities have improved. “We’ve seen some indication of the U.S. investor coming back, but it’s still a very small fraction of the whole that left in the last few years.”

Japan

It was a great year for Japan, but weak for emerging markets, which were down 15% to 20%.

He remains bullish on Japanese small-caps, in particular. “Following a 20-year bull market, [they’ve] fallen off the radar. A lot of the index has value traps, but if you strip that away, there are a lot of great franchised [companies] with good returns, steady cash flow and dividend yields. There are a lot of cheap companies out there.”