Is Now Time to Be Buying XLF, Financial Sector Exchange Traded Fund?

I don't wade often into stock speculation but this article in the WSJ caught my eye. It makes a case for buying XLF, the exchange traded fund for the financial sector. Good idea? I'm not sure it is.

I don't wade often into stock speculation but this article in the WSJ caught my eye.  It makes a case for buying XLF, the exchange traded fund for the financial sector.

In the article, Evan Newmark writes:

"The restructuring of the financial-services industry is well underway. We now know who most of the survivors are. We know there will be a lot less competition.

But we don’t yet know how the turmoil and the coming recession will impact the businesses and earnings of the survivors."

I'm not sure we do know who all of the survivors are.  Most analysts expect at least another 100 banks to do under and I wouldn't be surprised if some larger banks are part of that number.  The Fed bailout helps but it doesn't address the root cause of the problem, which is falling real estate prices.  The severe recession with rising unemployment is only going to exacerbate the drop in housing prices, putting further pressure on the banks.  Indeed, many see the Fed's intervension as nothing more than putting a finger in the dam.

Europe is starting to buckle and the global economy is facing a crisis not seen since the Great Depression.  I don't mean to sound alarmist, but just read the newspapers.  Europe had their one day largest percentage decline ever today, Iceland's banks are threatening to collapse, Germany had to bail out real esate financier Hypo while Belgium bank Fortis needed to be taken over to avoid a collapse.

This if all part of the massive unwinding of the debt economy that has developed over the last twenty years.  The scope of this unwinding is happening faster and deeper than I anticipated, but it is happening and it is not slowing, but gathering momentum. 

So, let's no turn to the XLF and now see if it presents a buying opportunity:

From a chart perspective, the damage is significant.  The index fund has lost over half its value since peaking last summer.  As Evan poinst out in his article, most of this damage occurred before the events of the last couple of months.

So, it is low and can it go lower?  I believe it isn't low enough but the main problem is, it won't be going any higher.  First, I think that the banks will continue to face significant problems and that there will be more bank failures in the US and abroad, failures that will continue to erase shareholder value.    I have a friend who says go with the trend and the trend is clearly down.  There is no sign that the banks are anywhere near recover.

And this brings up the second, bigger point.  Even when the banks recover and are functional again, I believe it will be a long time, perhaps a generation, before they are as profitable as they once were.  The last ten and maybe twenty years of profit are being flushed away.  The wealth of the financial services industry over the last ten years was a mirage.  What does that mean in recovery?  A more stable but much more boring business.

Remember the Nasdaq at 5,000?  Everyone thought technology would take over the world.  Where is the Nasdaq seven years after its crash?

It's at 1,823, higher than the post crash low of amost 1,000 but certainly nothing to write about.  And the technology crash was mild compared to the financial services collapse.

So, even if you do believe we are reaching a bottom the question becomes, what is the engine of growth for these companies going forward?  How are they going to generate profit that will raise their stock prices when the very things that contributed to their huge profitability over the last twenty years has been wiped out?

Until I get an answer to that question, I'm staying away.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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  • Sam Cass

    October 07, 2008

    Bank of America announced today they are cutting their dividend by 50% and issuing new shares. The stock is dropping like a rock.

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