Financial Services' Steady Strength

S&P thinks strong fundamentals and good momentum merit a positive outlook on their Diversified Financial Services group

From Standard & Poor's Equity Research

A recent addition to the is the S&P Other Diversified Financial Services subindustry index. This index consists of three large-cap companies, with Citigroup (C; recent price, $49) the largest component, accounting for approximately 33% of the group's combined market capitalization.

After underperforming the broader market last year—posting a 1.5% gain vs. the S&P 500's 3.8% advance—the index has flourished in 2006. Year to date through Aug. 25, this subindustry index has risen 7.8%, while the overall market has advanced 3.4%.

The rolling 12-month relative strength price chart demonstrates this recent outperformance. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500.


  Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 14-year mean relative strength.

Mark Hebeka, CFA, S&P's Diversified Financial Services analyst, is positive on the investment outlook for this group, which consists of global financial services companies that provide, among other things, commercial and consumer loans, insurance, and investment products.

Hebeka sees generally improving fundamentals for the group, but expects uneven growth rates among commercial, consumer, and market-related business lines. He thinks commercial and market sensitive businesses may accelerate in 2006, as he sees economic growth continuing. Overall, S&P expects consumer-based businesses to remain steady, although demand for mortgage refinancing products should drop significantly as interest rates increase.


  Second quarter results were largely in line with S&P's expectations, says Hebeka, reflecting, in his view, a strong global capital markets environment and solid trading results. In 2006, S&P sees economic growth enabling diversified financial companies to achieve healthy growth rates, as credit demand should expand as commercial businesses and corporations look to capital markets to sell additional equity and debt to finance future growth.

S&P believes steady consumer spending growth should keep demand strong for consumer credit products. S&P projects real GDP growth of 3.4% in 2006, higher than the 3.2% growth realized in 2005, and 3.9% in 2004. On June 29, 2006, the Fed raised its Fed Funds rate by 0.25% to 5.25%. S&P expects the Fed to increase rates an additional 25 basis points by the end of 2006.

For the longer term, Hebeka thinks that the major diversified financial services companies are better positioned than in the past to perform well throughout an economic cycle, since regulatory easing, in his view, has allowed companies to gather a broader spectrum of services under one roof. The key challenge for larger companies, according to Hebeka: building optimal business mixes that can sustain superior revenue and earnings growth.

So there you have it. Both strong momentum and healthy fundamentals indicate favorable price appreciation potential for these companies, in S&P's opinion. Citigroup carries S&P's highest investment ranking of 5 STARS (strong buy).

Source: Standard & Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

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