Why Investors Should Look At The Financial Sector (XLF, FAS, FAZ, SKF)

Don Lucek: Last week, I gave you several reasons why the Technology sector should prosper in 2013 and beyond. We also named the subsectors bound to lead the way.

Then I discussed the one Tech stock I’ve avoided and how I pick the best opportunities in Technology when managing Martin and Elisabeth’s retirement money in the Weiss Million-Dollar Ratings Portfolio.

Now this week, I’d like to tell you about another sector you should be watching now …

Financials, but with Extreme Caution

The Ratings Model started showing a growing interest in Financials during the summer of 2011, in the midst of the scare over U.S. sovereign debt. The Ratings pointed to better fundamentals ahead, despite investors’ soured mood toward a sector where increased regulation and low-interest rates could play havoc on companies’ bottom lines.

At the beginning of 2012 with the Ratings to back me up, I picked Financial as “sector of the year.” And that decision has been proven correct …

The Financials sector of the S&P 500 index has risen 20.76 percent (including dividends) so far this year as of Thursday’s close, beating the next-best-performing sector — Consumer Discretionary — by over 2 percentage points. I think the outperformance is likely to continue, and plan to overweight the sector in the Weiss Million-Dollar Ratings Portfolio as we move into the year-end rally I expect.

The Fed is issuing QE to infinity, and buying all the banks’ toxic mortgage-backed securities. So it’s a safe bet that easy money will continue to flow into this sector.

But you must proceed cautiously, because:

What happens in the short run if Europe implodes, and what is the American exposure if Spain or Italy or Greece literally cannot pay their debts? German and French banks are three times more leveraged than we are as a share of debt.

I've avoided Financials with excessive European exposure.
I’ve avoided Financials with excessive European exposure.

At the moment, I hold two up-and-coming financial stocks, which I expect to climb in the Ratings Model’s overall assessment. And since European exposure is a big concern, I’ve avoided companies that have excessive exposure to European debt.

I also hold a financial ETF as a proxy for the Model’s increasing interest and my growing fundamental expectations for the sector.

What’s Ahead for Financials

The central banks’ actions are undeniably pro-growth in nature. Over the next month or so, though, you can expect to see a lot of scary information regarding interest rates and their relationship to economic growth here in the U.S. and around the globe.

However, a unified Europe will help keep interest rates down. Plus the rebound in housing and consumer credit, where we’ve seen unexpected strength recently bodes well for Financials catering to consumer lending (credit and housing-related).

All of this should be enough to spark a renewed rally in this sector for the end of the year. Therefore, I’m sticking with my current holdings for now, as they are exposed to the sweet-spots I just outlined … consumer and housing exposure.

The Ratings Model favors big-dividend stocks at the moment, as it is inclined to do by nature. Yet my experience with the Model leads me to believe there are even better opportunities within the lower echelon of Buy-rated stocks in this sector. Those with the potential to rise in the Ratings versus those that seem more stagnant have been popping up more and more as the third-quarter earnings season draws to a close.

The rebound in consumer lending should boost Financials' growth.
The rebound in consumer lending should boost Financials’ growth.

There are regulatory constraints that will affect profits here. But I think that the Banking industry is still the most attractive of the Financial sector candidates. This is based not only on the rise and follow-through Bank Ratings have experienced, but through the improvements in fundamentals: Increased consumer credit and a resurgent housing market.

However, changes in interest rates could make insurers more attractive. And recent natural disasters, such as Sandy, will give us enough negative sentiment to increase my interest in that area in the short term.

So why are we so confident in the ability of these Ratings to shuck off the garbage and pick out the gems … and do so with consistent accuracy in both rising and falling markets?

Martin is very conservative. He’s concerned about the global debt crisis, the looming fiscal cliff, and the stock market as a whole.

So there’s only one way he will let me invest in the Financial sector — or any other sector: By faithfully adhering to the conservative Ratings he and I developed over a decade ago.

Thanks to these Ratings, which we now distribute with TheStreet.com, you can easily capture the upside of the market … but you also limit your downside by only investing in the strongest, most-profitable companies today.

You see, we follow three simple steps when I invest Martin and Elisabeth’s money so they don’t lose sleep in this topsy-turvy world …

Step 1. I always avoid the garbage — the lowest rated stocks that are most vulnerable.

Step 2. I use our Early Warning Alert system to continually watch out for downside risk. When I see the imminent danger of a decline, I add protective hedges.

Step 3. I select only the stocks that are likely to hold up relatively well in bad times and significantly outperform in good times.

However with politicians now the main driver of market volatility, we are now in a short-term market world. So in next week’s column, I’ll explain how the Ratings Model works in challenging times like these. Be sure to watch your inbox for it.

Related Tickers:  Direxion Daily Financial Bear 3X Shares ETF (NYSEARCA:FAZ), ProShares UltraShort Financials ETF (NYSEARCA:SKF), Financial Select Sector SPDR ETF (NYSEARCA:XLF),  Direxion Daily Financial Bull 3X Shares ETF (NYSEARCA:FAS).

Best wishes,

Written By Don Lucek From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaMare based upon data whose accuracy is deemed reliable but not guaranteed.  Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual   prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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