Are Some of The Best Blue Chip Stocks in the S&P 500 Financials Sector?

In light of our recent pieces, “Debt to EBITDA Ratios: The Spiral Higher Continues” and The Next US Financial Crisis: The Problem with Expensive Stocks and High Leverage,” KCR subscribers may find this research somewhat surprising.  In those pieces, we presented a blistering series of charts suggesting that the debt of US public companies and loans to Private Equity had hit record highs despite negative real-yields and a dearth of covenants.

In this piece, we will advocate for investors to dig in on US Financials Stocks.  Not to be confused with “Fin-Tech,” we believe the stalwarts of the US financial sector have rarely been as profitable, resilient, and of less interest to investors than they are today.

We believe that the “big picture” case for financials is fairly straightforward like our bullish view on Energy.  One of the great challenges in an epic financial mania like the current one is ignoring the noise.  Avoiding the screeching calls of get-rich-quick schemes can be challenging.  Neighbors and friends suddenly seem to have achieved wealth without work.

At the same time, however, as manias hit levels of absurdity like the current one, the opportunity to buy blue-chip companies at reasonable prices tends to emerge.  That is what happened in the internet mania, and we believe the same phenomenon is unfolding today.  We are enjoying this period of highlighting pockets of unusual opportunity and believe, with the appropriate stock-level diligence, our contrarian thematic pieces may yield uncommon returns for investors focused on the long run. Figure 1 below shows:

  • The weight of Financials is ~11% today in the index
  • In the trough of the Great Financial Crisis, Financials were ~9%
  • We believe many “old-fashioned” Financials are as interesting as any time in our investing careers

We believe that Financials’ representation in the index, like our chart on Energy, is a sign of the times.  Enamored with the novel investments promising exponential returns, investors are ignoring Financials despite their healthy balance sheets and record profits. 

Despite Record Profits Strong Liquidity Financials Representation has Rarely Been Lower

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The prior chart showed that the weight of Financials in the S&P 500 is barely above the levels seen at the trough of the Great Financial Crisis.  The chart below shows financials’ profits as a percentage of the overall profits generated by the entire S&P 500. 

[1] “Total Addressable Market”

[2] Federal Reserve, Funding Risk, pages 37-45

[3] Please check out the Appendix for a review of the degree to which financials are benefitting from abnormal earnings

Disclaimer

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