Friday, January 15, 2010

US Strategy: Circle of Life Focus on Financials. Taking off Energy trade. Still Pro-Cyclical.

Our working thesis remains that the trajectory of US recovery should be considerably more robust than consensus, and hence we remain constructive on equities. Recent data, including the December employment report, were a disappointment, but GDP per worker is now more than 2% above its 2007 peak, and historically, positive payrolls follow within 4 months of achieving that milestone, implying January 2010 (see “US Equity Strategy FLASH: Surge in GDP per worker suggest positive payrolls by early 2010. 15 ideas to leverage payroll turn” dated 10/29/09). December Retail sales painted a confusing picture, showing the YoY gains of 2009 but down MoM (seasonals here?). Still, we still recommend investors to be steady buyers of equities and heavily favor pro-Cyclical groups over Defensives, given the upside trajectory and commensurate upside to EPS. We still see the S&P 500 reaching 1300 by YE10.

• FOCUS ON FINANCIALS. REMOVE ENERGY TRADE. We believe investors should focus on Financials among the pro-Cyclicals, and we are taking off our Energy trade which has outperformed by 470bp since it was established in August. Financials have lagged the S&P 500 by 690bp since 9/30 due primarily to $65b of Financial equity issued 10/1-12/31, representing 96% of all stock issued at that time.

• 5 REASONS FOR FINANCIALS POTENTIAL OUTPERFORMANCE. (i) Several leading indicators suggest loan growth should soon improve including demand from small business; (ii) Potential for 2010 credit losses lower than Street expectations due to employment upside; (iii) Gigantic capital raises behind Sector which issued $300b in equity in past two years; (iv) Potential for dividends to double over next few years as earnings stabilize; (v)Financials at attractive valuations on P/TB of 1.6X below 2.2X LT avg and in-line w/1991, which saw Financials outperform by 1,279bp over next 12 months. Those w/ P/TB below 1.25X did even better, outperforming a further 1,700bp (vs. Financials).

• 19 FINANCIAL STOCK IDEAS: We identified 19 Financial stocks that JPM Analysts have a positive variant view (OW vs. Consensus) and P/tangible book less than 1.25X. These 19 stocks are: MF, HIG, C, BDN, ENH, UMPQ, RE, PRE, ACE, MFA, RGA, AIZ, DEI, EPR, PRU, CMA, NLY, MET, and AGO.

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