Global Financial Industry: More Upside Ahead?

Bloomberg's David Wilson presents a UBS study showing sustained bullishness for the global financial industry.

We quote Mr. Wilson, (all bold emphasis mine)

``Financial stocks are poised to keep rising worldwide after posting this quarter’s best performance, according to Jeffrey Palma, a global strategist at UBS AG.

``The industry stands to benefit from “a much improved backdrop,” Palma wrote yesterday in a report. He recommended that investors increase their percentage of assets in financials to a “modest overweight” relative to benchmark indexes. They had been “neutral.”

chart from Bloomberg

``As the CHART OF THE DAY shows, financials are headed for the second quarter’s biggest gain among the 10 main industry groups in the MSCI World Index. They last set the pace in the second quarter of 2003, according to data compiled by Bloomberg. The chart has the MSCI World Financial Index's quarterly rankings and percentage moves during the past six years, including this quarter’s gain through yesterday.

``Relatively steep yield curves globally will help financial companies lift earnings, Palma wrote. The gap between yields on two-year and 10-year U.S. Treasury notes reached 2.76 percentage points, a record, on May 27. Falling loan-loss provisions and rising asset values, including share prices, may also lead to higher profits, the report said.

``There is still room for profitability to recover” even if the industry’s return on equity stays well below its 16 percent in 2007, Palma wrote. He favors banks in Australia, Canada and emerging markets.

``Financials amount to 20 percent of the MSCI World Index’s value, more than any other industry group, according to data compiled by Bloomberg."

My Comment:

All financials aren't cut from the same cloth. My impression is that the financials in the bubble bust afflicted economies (such as in the US or UK) may seem like landmines that could be triggered by a wrong move. Such risk remains until the issue of toxic assets in the industry's balance sheets are resolved.

Although I do share the enthusiasm for emerging markets and Asian financials, primarily on the steepening yield curve dynamics as previously discussed in Steepening Global Yield Curve Reflects Thriving Bubble Cycle, which should augment profitability, enhance lending and induce more risk taking.

However, cyclical weakness could be in the short term horizon given the bearish head and shoulders formation as seen below.

chart from stockcharts.com

But for as long as the dynamics of liquidity and wide spreads across yield curve persists, we should use this dips as buying windows.

In essence it is all a matter of time horizon, possibly short term weakness with strenght going into the medium to the longer term.