There is a lesson to be learned in todays market. If the market is efficient, there will be no outperformance as information is available to everyone at the same time.
We see that the US financial sector is expected to have the best operating margin (31%) in 2022. Its EV/EBITDA is 7.2x which is also the lowest compared to all the other sectors. The financial sector is also trading at the lowest PB relative to all the other sectors. And yet, we see the financial sector pulling back since the turn of the year. Not only that, interest rate hike is positive for financial stocks as NIM expands resulting in better profitability.
Then why are the financial stocks pulling back. My guess (since no one can really predict the market) is that the market is pricing in a recession. Who on earth is able to do that? It’s still a question whether US will head into a recession on not, how much more how long, if the recession materialised, it will last. For those who are looking into buying bank stocks, need to have at least 2 years of time horizon as meantime, they will face some volatility as a result of rising cost which impact on its margin. Trading activities have slowed compared to a year ago which will also impact negatively on banks earnings.
Job market looks pretty strong at this moment and unemployment numbers are below the FED target of below 4%. Oh yes, the inflation, fuelled by the continued locked down in China and the Eastern European crisis. Somehow, FED is seen in a tight spot. Raising rates too fast will ensure disruption to US economic growth, raising it too slow will fail to contain inflation.
So what are they going to do? Anyone’s guess. My personal opinion is too many headwinds facing the market today and many are trying to predict what is the direction going forward in the next one year. If the efficient market hypothesis is right, then we are all forecasting in vain. It is exactly what we are doing (predicting and forecasting) that makes this market efficient. The actions that we do as a result of our belief that market is inefficient that makes this market efficient. What an irony!
Interestingly there are not many options for investors. Hold cash is a sure way to “lose” money in such a high interest rate environment. Buying fixed income doesn’t make sense as well as interest rates going higher will possibly push bond prices down (which is what is happening now, investors selling ahead, thus pricing in a hawkish FED).
Not many choices left, investing in Gold at current price doesn’t sound right from the risk-reward perspective.
We are left with equities. Value stocks may just be the next asset class that investors will buy up, once the dust has settled. On that front, US financial sector seems pretty logical to me from the value perspective.
Companies with pricing power, which are generating positive FCF year in and year out will be attractive to me as well after the recent pullback in prices. This is especially true for the big tech names like MSFT, Amazon, Aphabet, Apple. Growth-turned-value stocks like Intel and IBM. And last but not least, Financial stocks like BAC, JPM and BK.
