By Beth Piskora On Dec. 8, Standard & Poor's upgraded its recommendation for the financial services sector to overweight from marketweight. "Financials look good to us fundamentally and technically," says Sam Stovall, S&P's chief investment strategist. "And they play into our 'quality' theme; we expect higher-quality companies to attract more interest in 2006 than they have in 2005." Financials join consumer staples and health care as the sectors for which S&P advises an overweight position. Financials make up 21.3% of the S&P 500 index.
"S&P is positive on equities in 2006, with an emphasis on dependable, high-quality companies as the economy slows and earnings decelerate," explains Stovall. S&P's proprietary quantitative metric, the S&P Earnings & Dividend Rank, also called the S&P Quality Ranking, measures the consistency of earnings and dividend growth over the most recent 10-year period. The financials sector, with 68% of the companies having superior S&P Quality Rankings (A- or higher), is second only to consumer staples.
In addition, S&P's forecast for a first-quarter 2006 end to Federal Reserve monetary policy tightening will likely bolster the financials sector's performance, Stovall says. S&P analysts have a positive overall fundamental view on the sector, which sports a market-cap-weighted STARS ranking of 3.9 out of 5, above that of the broader index at 3.7. From a technical standpoint, S&P has a positive outlook based on a recent breakout above five-year resistance and improved relative strength vs. the broader S&P 500 index.
Within the financial services sector, favored sub-industries include diversified banks, multi-line insurers, property and casualty insurers, and investment banking and brokerage. Investment banks look very attractive to Robert Hansen, an S&P equity analyst. "We believe higher investor confidence, higher trading volume, a rebounding equity market, and strengthening IPO and merger and aquisition activity will help investment banks," Hansens says. He recommends Goldman Sachs (GS
; ranked 5 STARS, or strong buy), Bear Stearns (BSC
; ranked 4 STARS, or buy), and Merrill Lynch (MER
; ranked 4 STARS, or buy).
Hansen also expects further consolidation among asset managers. His top-ranked picks in that industry group include T. Rowe Price Group (TROW
, ranked 5 STARS, or strong buy) and Franklin Resources (BEN
, ranked 5 STARS, or strong buy). Hansen notes that the potential depreciation of the U.S. dollar, which S&P expects in 2006, would particularly help Franklin, since 40% of that company's assets under management are held in foreign equity mutual funds.
Insurance is another strong industry group. Earlier this week, S&P insurance equity analyst Cathy Seifert raised her fundamental outlook for multi-line insurers to positive. Her favorite stock in the group is Hartford Financial Services Group (HIG
, ranked 5 STARS, or strong buy).
Among all the sectors, Standard & Poor's recommends that investors have overweight positions in financials, consumer staples, and health care. It has an underweight recommendation on consumer discretionary, materials, and telecommunications services. And it thinks investors should marketweight energy, industrials, information technology, and utilities stocks.
Standard & Poor's Investment Policy Committee set a yearend 2006 target for the S&P 500 index of 1,360, representing upside of 6.7% for the year. The committee adjusted its yearend target for 2005 to 1,275. By June 30, 2006, the committee expects the S&P 500 index to hit 1,315. Piskora is managing editor of S&P Global Editorial Operations