XFN, Capped Financials, again

XFN july 19 2013

This ETF contains both the banks and insurers. The banks really shot up during the 1993 to 2000 period after which the insurers started to do the same as a result of their de-mutualisation. The top in 2006 therefore marks the end of a lengthy period of prosperity here in the Canadian financial sector. The question now is , was this an extreme or part of a normal progression. In the States there is hardly any doubt that when banks accounted for , give or take, 40% of all corporate earnings that they had grown a bit too much. Here the numbers were not that extreme but nevertheless it is difficult to understand why these institutions collectively trade at $26, just $2 below their all time peak , unless one assumes that their oligopoly position will continue to allow them to extort unlimited “rents” in the future. Here are a few points to contemplate;

1. Contrary to public perception the Canadian financial institutions did receive comparable bail-out packages even if the word bail-out would be somewhat of a misnomer. A total of $125  bln. was pumped into the system, rates were dropped sharply (initially good for lending institutions) and , over time, the CMHC ended up insurer about $600 bln+ of mortgages , which is about as much as the entire public debt and on a par with Fannie and Freddie in the US. This will end.

2. Regulation is increasing and the rules for certain financing activities have become less relaxed. Clearly this should have a detrimental impact on future business and the cost of doing business.

3. In an environment where borrowing is considered to be the cause of much of world’s setbacks it is difficult to see how banks, Canadian or otherwise, can grow that part of their businesses. Fee related things like credit cards etc. will be the name of the game.

4. It is doubtful that things like “wealth management” or going overseas are going to pick up the slack elsewhere. Going after insurance business and or car financing often cannibalizes other players in this group.

5. Trading is no doubt becoming more difficult, particularly if you are not part of the “inner circle” as with JPMorgan, Goldman etc.

The list goes on but the point is essentially that there is no good reason why these institutions should trade $2 below their peak. The EW count suggest they won’t and could, in fact, go down dramatically any moment now.