Sector Analysis/Financial Stocks

By: Charles Meek | Mon, Oct 25, 2004
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Dow Jones Industrial Average 9757
Value Line Arithmetic Index 1565
30-Year Treasury Index 4.76%

The Big Picture for Stocks
We're most likely in the bear market side of the 4-year cycle, which could carry into 2006.

Technical Trendicator (1-4 month trend):
Stock Prices Down
Bond Prices Down

I recently offered a list of industries that could be vulnerable. Here's a recap of the list:

The financial sector in particular is of some particular concern. This sector is now the largest sector by market cap in the S&P 500. It represents 20.6% of the S&P, up from only 6% in 1980. That in itself is probably a sign that the sector is over-owned.

I call your attention to some facts and late breaking events:

JP Morgan/Chase had a large earnings miss, reportedly due to a bad bet on the bond market. Banks, especially this one, are known to have large derivative portfolios. Morgan/Chase has Derivatives Credit Exposure to Risk Based Capital of 768%. This compares to HSBC of 285%, Citigroup of 264%, and Bank of America coming in at 208% (source: There is a risk of serious problems here.

In the comments above, we suggested problems for lenders when the mortgage boom stopped. Well, Countrywide Credit announced a large earnings miss just for that reason. The boom is probably over and there is more bad news coming for the lenders.

Fannie Mae is also in the news. Management has been doctoring the books to smooth out earnings. But that is probably not the end of the story. Fannie's Equity to Total Capital Ratio is a scant 2.6%. This compares to 4.2% just ten years ago. This company may be too leveraged to withstand a real pullback in the housing industry.

Even venerable AIG is in the news in a bid-rigging charge with the insurance brokerage companies. This is evidence that, as I said before, there is too much competition in the financial sector.

The brokerage stocks have stayed out of the news. But I am concerned about this segment of the financial services industry as well. This business has been too profitable to support the fact the customers are not making much (if any) money. I suspect that there is on the horizon a dogged period of less profitability for stockbrokers.

We remain short the Financial Select Sector SPDR (XLF), as well as individual companies within the this broad sector.


Charles Meek

Author: Charles Meek

Charles Meek

Mr. Meek is a Registered Investment Advisor and editor of

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