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Making the Bull Case for Financials Courtesy of QE3


The biggest impact of QE3 on the banks is the promised stability it offers the housing market. This translates to improved stability for banks that are holding US mortgages.

The financial services sector has been sitting in its time-out chair for at least four years now. The sector has really never recovered to the pre-2008 financial crisis levels. Any optimism that it might recover to those levels soon is probably misplaced. However, the sector has some nice room to still run over the long haul, and I'll make that case below.

We know the two biggest reasons financial services stocks are still so depressed compared to 2007 levels: (1) given the new rules that they are forced to play by, they will not get back to their pre-2008 earnings levels any time soon, and (2) many banks continue to carry "problem" assets on their books that make valuation difficult to gauge.

Let's review these two areas before we make our bull case for financials. Wall Street's pre-2008 earnings levels are a distant memory. These firms will never again be allowed to use the leverage they used or make the risky bets with capital that they once made. And rightly so, as we saw the outcome of risk investment capital gone wild during the financial crisis.

As a result, the earnings potential of these firms is now capped. On top of that, with these firms taking less risk, they have lower reward potential (read: lower reward potential as lower growth potential). With lower growth potential, the industry will see a lower PE ratio. That is just a basic tenet of investing!
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