In search of a great unloved sector, Oakmark Funds’ Bill Nygren (Trades, Portfolio) vouched for financial stocks in 2016. He had 18 in this portfolio at the end of the fourth quarter, and in spite of their downward slide this year he hasn’t changed his mind.
Financial stocks have come in dead last in S&P sector performance year to date, falling 7.3% and trailing the S&P 500 stock index’s 0.10% decline. Some of the industry’s bellwethers to tumble this year were Bank of America (BAC, Financial), down 21%; JPMorgan (JPM, Financial), down 10%; and Citigroup (C, Financial), down 19%. Nygren saw the falter as primarily a combination of two factors.
“Interest rates remained at decades-low levels during the quarter, fueling ‘lower for longer’ concerns, which along with worries about energy exposure added further pressure to the Fund’s financial stocks,” his first quarter 2016 letter said. Even investor Michael Burry, who foresaw the financial crisis, has five bank holdings in his concentrated portfolio of 13 stocks.
To paint the short-term headwinds picture, the market knows prolonged low interest rates may negatively impact banks’ net interest margins and earnings. Several of the banks’ first quarter earnings reports come out this week. In addition, while the Federal Reserve indicated it would continue to raise interest rates in 2016, uncertainty about whether they will is growing.
Value investors hold that banks’ fundamentals have improved enough from the financial crisis that the market has temporarily mispriced their strong assets based on these short-term setbacks.
Others, such as Janus Partners’ Bill Gross, say that the setbacks would actually run long term if the Fed decided to implement negative interest rates. Investors enticed by high yield and low price-book ratio of the stocks should instead recognize their increased regulation that will result in future return on equity more akin to a utility stock, he said in his latest Investment Outlook report.
Bill Nygren (Trades, Portfolio) has led the Oakmark Fund since it started in 1991. It contains 55 equity holdings, is composed more than one-third of financials and has net assets of $17.1 billion. Nygren’s biggest holdings in the financial industry at the end of the first quarter are: Bank of America (BAC, Financial), Citigroup (C, Financial) and American International Group (AIG, Financial).
Bank of America (BAC, Financial)
Bank of America reports its first quarter 2016 results Thursday, and its most recent results are for the fourth quarter. Over a longer timeline, the bank has not come close to achieving its pre-2008 returns on equity despite higher revenye. It has a 5.7% ROE for the trailing 12 months ending in the fourth quarter, fallen from 10.4% in 2007 and double-digits of each prior year of the 15-year period.
Bank of America revenue has also dipped steadily for the past three years, at $82.5 billion for the trailing 12 months, still above the 2007 level and each prior year for the 15-year period.
At $13.79 per share at close Wednesday, Bank of America trades at almost half of book value, with a price-book ratio of 0.61.
Nygren held 35.5 million shares at fourth quarter-end, a 3.7% portfolio weight.
Citigroup also has an annual return on equity since 2007 lower than six years prior, when it was in the double digits. For the trailing 12 months, it reached 7.5%, slightly lower than 2015 and its highest in the past eight years.
The bank’s revenue has remained around the same level since 2011 and totaled $76.4 billion.
At $44.25 per share, Citigroup also trades near half of its book value, with a price-book ratio of 0.6.
Nygren held 9.03 million shares of Citigroup, a 2.9% portfolio weight.
American International Group (AIG, Financial)
AIG reports its first quarter 2016 financial results on May 2. The insurance giant’s return on equity for the trailing 12 months at 2.16 is its lowest in four years, and lower than it was annually from 2001 to 2009 and is on a downward trend.
For the past three years, AIG’s revenue has been in decline, totaling $58.3 billion in 2015 – its lowest since 2008.
Closing at $55.14 per share Wednesday, AIG has a price-book ratio of 0.7.
Nygren held 7.305 shares of AIG, a 2.79% portfolio weight.
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