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Analysis: Financials near to regaining S&P 500's top spot

Traders work on the floor of the New York Stock Exchange August 9, 2013. REUTERS/Shannon Stapleton
Traders work on the floor of the New York Stock Exchange August 9, 2013. REUTERS/Shannon Stapleton

By Alison Griswold

NEW YORK (Reuters) - It's hard to overstate the damage that the banking crisis caused financial stocks.

At their peak on June 1, 2007, the stocks in the Standard & Poor's 500 financial sector index had a collective net worth of more than $2.9 trillion, roughly 30 percent greater than that of the next largest group, tech stocks.

Then the housing bubble burst, and their market value plummeted by $2.4 trillion, a drop of 83 percent, compared with the broader S&P 500's 58 percent swoon. When financial stocks hit bottom in March 2009, the whole group was worth just $510 billion, roughly the equivalent of the combined pre-crisis market value of JPMorgan Chase & Co. and Citigroup.

Such a fall makes their comeback all the more remarkable: The financial sector stands within a whisker of recapturing the mantle as the $17 trillion U.S. stock market's heaviest hitter.

At present, the financial index accounts for 16.6 percent of the entire S&P 500 - about 1 percentage point less than the technology sector, data from S&P Dow Jones Indices showed. At the start of the year, the gap between the two stood at about 3.5 points.

"The psychology toward banking has been so incredibly negative, and the big financial gurus were so negative, that they completely missed the fact that the banking industry was showing this gradual steady improvement," said Dick Bove, bank analyst at Rafferty Capital Markets in Tampa, Florida. "In the past couple weeks, they're all saying, 'Banking is back.'"

Financials have added nearly 25 percent this year, lagging only healthcare and consumer discretionary shares. Should they surpass tech, they would top the S&P's 10 industry sectors for the first time since May 2008. At the market low on March 9, 2009, they had a market weight of just 8.9 percent, the smallest since 1991, when the S&L crisis was in full rage.

For the most part, big banks are driving the growth. JPMorgan Chase, Wells Fargo, Citigroup and Bank of America have provided the sector's biggest boost. Each has gained at least 24 percent so far this year.

Wells Fargo, the nation's largest bank by market value, hit an all-time high in late July. This year, the stock has risen nearly 27 percent, on track for its best year since 2000.

MORE UPSIDE?

Banking stocks may have even more room to run, according to an analysis by StarMine, a Thomson Reuters company.

On balance, stocks in the group trade at about 76 percent of their StarMine intrinsic value, which evaluates a stock based on projected growth over the next decade, using a combination of analysts' forecasts and industry growth expectations. By that measure, tech shares are 8 percent overvalued.

Sector heavyweights Citigroup, Bank of America and AIG are considered cheaper than more than 90 percent of the market. Citigroup's intrinsic value is $88.57, better than 70 percent above its current $51.32. StarMine sees comparable upside for Bank of America, pegging its intrinsic value at $25.62 versus Friday's closing price of $14.45.

"The problem with the refinancialization of the U.S. economy is it puts us at greater risk for another financial collapse," said Barry Ritholtz, chief executive and director of equity research at Fusion IQ in New York.

"The collapse started the process of definancializing, and now we're back to refinancializing."

Meanwhile, several of the largest banks remain in the crosshairs of authorities. This week, the U.S. government accused Bank of America of fraud in its sale of mortgage-backed securities.

JPMorgan, struggling to repair its reputation since losing more than $6 billion in 2012 on its so-called "London Whale" derivatives trades, is under both criminal and civil investigation for its own MBS sales.

For the week, financial shares slipped 1.9 percent, exceeding the S&P 500's pullback of 1.1 percent. Still, the stocks have posted double-digit gains for four of the past five years, and are on pace for a fifth straight quarterly rise.

Traditionally, steady performance by financial stocks was seen as a promising sign for the economy, as increased borrowing and lending helps businesses and individuals by encouraging consumption and job creation.

Through 2007, bank stock prices far outpaced the broader market. After the recession, though, they languished while others, such as consumer and energy shares, did well. Their sluggish performance in the early years of the recovery reflected not only the headwinds of a stiffer regulatory environment, but the slow rebound in demand for credit.

TECH HAS ITS DEFENDERS

Some in the financial industry say tech should remain in the top spot, a perch it has held for more than five years now.

"Tech, in my opinion, has more redeeming underlying value than finance," said Ralph Shive, portfolio manager of Wasatch Large Cap Value Fund in South Bend, Indiana. "Technology usually adds value, adds productivity, creates value out of thin air."

Goldman Sachs, in a research report earlier this month, ranked financials among the weakest S&P 500 industry sectors in terms of value and growth. The tech sector earned the highest marks.

Others contend that the financial sector's advance over tech can be healthy for the economy, so long as the market cap of the financial index does not swell to levels that historically have proved unsustainable.

Right before the tech bubble burst in 2000, for example, the S&P 500 tech sector amounted to 34.5 percent of the index - the highest percentage of the S&P that any sector has ever reached, S&P Dow Jones data shows.

"Now that financials and tech are relatively equal, that is an indicator that the market is very balanced at this point in time," said Doug Cote, chief market strategist at ING U.S. Investment Management in New York. "Those have traditionally been the biggest two sectors."

(Reporting by Alison Griswold; Editing by Dan Burns, Steve Orlofsky and Jan Paschal)

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