Morningstar Advisor - February/March 2012 - (Page 18)

Talking Points Have Financials Gotten Cheap Enough? The sector got pummeled in 2011, but not without cause. The Issues Financials of all stripes, but banks in particular, got destroyed in 2011. The financial stocks in the S&P 500 Index were down about 23% collectively through November, which was far worse than the overall index’s 5% loss. After rebounding in 2009 and 2010, financials were taken down by Europe’s sovereign debt crisis, lingering balance-sheet woes, and anemic growth prospects. This environment is somewhat reminiscent of the early 1990s’ hangover from the S&L crisis. Back then, banks reeled from the collapse in commercial real estate values. Similarly to today, bank stocks sold at single-digit P/E ratios as they struggled to work through bad loans amid weak economic growth. Yet this crisis has arguably been worse, with potentially longer-term ramifications. The 2007–08 credit crisis leveled the housing market, which is much larger than the commercial real estate market. Plus, the S&L crisis was more regional, while this has been global, and it has ravaged the financial system. This combination, coupled with a down housing market, could curtail loan demand for years. Quotable “We have no religious aversion to banks. It’s still very difficult to answer questions about their balance sheets. Another question: Will the business look like it did in the past? No. Leverage will be constrained.” Keith Trauner GoodHaven GOODX “We have sought to minimize our exposure to global banks for fundamental reasons, though they could also be affected by the European debt crisis. Many of these banks fail to meet our dividend-yield requirement and are probably years away from normalized earnings levels. Instead, we have sought to focus our financial exposure on high-quality regional banks, investment managers, and insurance companies, many of which are trading at or below their book values.” Clare Hart JPMorgan Equity Income HLIEX “Bank of America won’t have to pay taxes for a few years. They’re making money and they keep reserving for the puts and warranties.” Bruce Berkowitz Fairholme FAIRX The Points r While the operating environment may remain challenging for years to come, this is potentially priced into the stocks. Currently, the stocks in the S&P 500’s financials subsector trade at an average price/fair value, or P/FV, of just 0.67, as estimated by Morningstar equity analysts, versus an average 0.82 P/FV across the coverage universe. r Banks generally have far stronger balance sheets than they did before the crisis began four years ago, but risks remain. For example, Bank of America BAC must still worry about the $2 trillion in mortgages that it and acquisition Countrywide Financial originated from 2004 to 2008. r In the 1990s, banks recovered partly by leveraging up their balance sheets and earning high returns on equity. Given the tougher capital requirements coming down the pike, this is unlikely to be repeated. Thanks to low yields, the profit outlook for banks also looks weak relative to the early 1990s. Bank of America’s most recent net interest margin was just 2.3%, and it’s unlikely to improve anytime soon given the Fed’s pledge to keep rates close to zero until at least mid-2013. r Some managers are finding opportunities outside of the banks. Insurers and asset managers have relatively attractive valuations, but without the balance-sheet issues. Ed Bousa of Vanguard Wellington VWELX reduced the fund’s stake in Bank of America, even though he believes that it will eventually recover. Instead, he has added to BlackRock BLK, which has seen steady flows into its mutual funds and exchange-traded funds. 18 Morningstar Advisor February/March 2012

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

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