Should investors bank on better financial sector performance?

There’s one sector that is particularly integral to the health of world economies, industries and capital markets – it’s the financial sector. As a major source of business financing, it is a key driver of corporate and economic growth; as a major part of the broader market, its performance can potentially do some serious harm or good to an equity index near you.

Due to concerns about loan yield spreads (where creditors can increase their profits) and the economy (if creditors are unwilling to lend money in light of flattening loan yield spreads), the financial sector has underperformed, leading to a withdrawal of sorts by investors, pulling down the broader market in the process.

What lies ahead for the financial sector? Should investors bank on better performance in the future? Many analysts have a neutral outlook for the group.

On the positive side:

• Discounted valuations
• Relatively attractive dividend yields (increasingly appealing to today’s investors)
• Evidence of well-contained inflationary pressures (therefore, no dramatic, harmful interest rate hikes on the horizon)
• Signs of ongoing economic growth
• Some steepening in the yield curve (which should help improve sentiment toward the financial sector and economy, barring an unforeseen jump in inflation)
• Increased merger & acquisition activity across the economy (increasing demand for brokerage services)
• Strong performance potential of the life insurance and property & casualty insurance groups (both solid defensive plays in today’s challenging market environment)
• Online and traditional brokerage takeover speculation (providing some support for their stocks)

On the negative front:

• Concerns about interest rates and, in turn, economic growth (the current flattening of the yield curve suggests a period of markedly slower growth in the near future)
• Overall cautious stock market outlook (ironically made worse by the financial sector’s recent poor performance)
• Lower levels of financial market trading activity (decreasing demand for brokerage services)
• After-effects of the bid-rigging scandal (dealing with the insurance brokerage group)

Some of the stocks that fall into this group include the following: Allstate, American Express, Bank of America, Bear Stearns, Brascan Financial, Canadian Imperial Bank of Commerce, Charles Schwab, Citigroup, Clarica Life Insurance, Franklin Resources, Goldman Sachs, Laurentian Bank, Lehman Brothers, Maritime Life, MBNA, Merrill Lynch, Merrill Lynch & Co., Canada, Power Financial, U.S. Bancorp and Wells Fargo.

May 2005

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.