Is Wall Street Dead? No, Just Moving
03/23/2010 10:15 am EST
The financial sector didn't die in the collapse of 2008—it just got scattered. Here's where in the world you can find investment opportunities as a new order is born.
All we need are Will Smith and some zombies.
Tattered "For Rent" signs hang in the windows of the building that once housed Bear Stearns. All that's left of Lehman Brothers is a digital crawl that endlessly cycles news. American International Group (NYSE: AIG) keeps itself alive by selling body parts. HSBC (NYSE: HBC) has retreated to its ancestral island fortress, far away from the fields where it went down in defeat before the pitiless hordes of the mortgage-backed securities market. The ghosts of Wachovia and Washington Mutual flit through quarterly financial statements. Citigroup's (NYSE: C) Citibank branches offer promises to cynical customers.
Everywhere you look, you can see the ruins of the old financial order.
But in those ruins, like the green grass sprouting among the fallen stones of Sicily's Agrigento temples, you can see signs of the new financial order. Old players have been reborn. New leaders have risen to assume the mantle of the fallen. New opportunities beckon the brave and unbloodied.
It's still early. The green shoots are just shoots. Early leaders may falter. But this is also the time to start staking out positions in the stocks that could—if things break right for these companies—be the leaders of the financial sector for the next cycle, whether it's for just a few years or a few decades.
Here's my thinking on what that new financial order will look like, divided into five parts.
The Creatures That Ate AIG
Before the financial crisis, the AIG subsidiary AIA Group ran one of the most exciting financial businesses in the world. After 90 years in the region, the company had built up a network of 250,000 agents in 13 Asian markets. The company had 20 million customers and $60 billion in assets, and was a life insurance powerhouse in a region projected by consulting firm McKinsey to generate 40% of all growth in global life insurance premiums in the next five years.
AIG subsidiary American Life Insurance, or Alico, did business in 50 countries. Its biggest developed market was Japan, where, before the financial crisis, the company was the country's number four insurer. (Alico had name recognition of 99.2% in Japan.) Alico's business in the fast-growing markets of the Middle East, Russia, and Latin America balanced the subsidiary's presence in Japan's mature life insurance market.
After the crisis, these companies don't belong to AIG anymore. MetLife (NYSE: MET) bought Alico, and Prudential PLC (NYSE: PUK) of London bought AIA.
Ready to Rumble in Asia
The sales of Alico and AIA haven't restored the status quo in Asian financial markets—not by a long shot. The AIG brand took a big hit in Asian markets because of the company's near run with bankruptcy, and it's going to take work by the new owners to rebrand that business.
(Especially because the Alico portfolio contains some risky and illiquid assets that will need a lot of attention. There's $5.3 billion in commercial mortgage-backed securities and $1.3 billion in Greek bonds, for example. I think MetLife has the balance sheet to handle the strain, but it won't be easy.)
And it's not just AIG that saw its reputation tarnished. HSBC, Citigroup, ING (NYSE: ING), and Australia's Macquarie Group (OTC: MCQEF), to name just a few, took hits to their reputations in the crisis, retreated from these Asian markets, or both. That has opened the door for financial companies that escaped the worst of the crisis and that already have a presence in the region, such as Canada's Manulife Group (NYSE: MFC), Spain's Banco Santander (NYSE: STD), and the United Kingdom's Standard Chartered (OTC: SCBFF), to pick up share in the world's fastest-growing markets for financial products.
NEXT: Rise of Developing World Financial Powers|pagebreak|
It Doesn't Run All One Way Anymore
The crisis accelerated a trend (or maybe just accelerated our awareness of a trend) that I'd call the rise of developing world financial powers. The biggest initial public offerings in 2009 were Chinese and Brazilian—and were done in the Chinese and Brazilian financial markets.
Through the end of November, 72% of the money raised in IPOs for the year came from Asian and South American deals, according to Ernst & Young. By funds raised, the top three markets for IPOs were the Hong Kong stock exchange (18.7%), the New York Stock Exchange (17.9%), and the Shanghai stock exchange (17%).
That trend in IPOs is just an indication of a larger trend in global capital markets: The developed world's share of global capital is falling. In 2004, US capital markets accounted for 53% of all the shares of stock in the world that were free to trade. By 2007—a year I picked because it was before capital markets everywhere felt the full effects of the global financial crisis—the US share was down to 44%. So which financial companies are picking up the slack? Look to recent stock offerings in Brazil to see one cast of emerging players. The big offerings have included Banco Santander and Itaú Unibanco (NYSE: ITUB).
One of the reasons that HSBC moved its CEO back to Hong Kong from London and is preparing to list on the Shanghai stock exchange is its desire to participate in China's IPOs. China's big banks and investment companies have the bulk of that business now. (UBS (NYSE: UBS), headquartered in Switzerland, was the top developed-economy investment bank in the Chinese IPO market in 2009, earning $728 million in fees on Hong Kong IPOs worth $26 billion, according to Bloomberg.)
The mergers and acquisitions market, however, remained a stronghold for developed-economy financial companies. Morgan Stanley (NYSE: MS) was the top adviser, on deals worth $20.9 billion, in China's mainland and Hong Kong stock exchanges.
Another Tiny Step in Banking Sector Consolidation
Since the beginning of 2008, the Federal Deposit Insurance Corp. has closed down a little more than 200 banks (you can get the list, updated weekly, here). That sounds like a lot, but it's actually a drop in the bucket compared with the more than 7,000 FDIC-insured banks in the United States.
In reality, what the crisis has produced is some significant consolidation among the country's biggest banks, but almost no consolidation below that level. At the top, the banks that got bigger, in ways that I think will increase profits for shareholders, include JPMorgan Chase (NYSE: JPM) and Wells Fargo (NYSE: WFC). US Bancorp (NYSE: USB) has done a good job at picking up pieces of smaller banks—and sometimes whole banks—to extend its footprint in new and existing markets.
One Revolution Stalls, Another Quietly Rolls on
By the second quarter of 2007, before the financial crisis went critical, the traditional banking sector accounted for less than half of the assets in the US financial system, according to a 2009 report (.pdf file) from the New York Federal Reserve. The majority of the financial system's assets was in the hands of financial institutions that raised their capital not from traditional sources (deposits), but by borrowing from the financial markets themselves (by issuing short-term commercial paper, for example) or by selling securitized assets on the financial markets.
Securitization allowed what has come to be called the "shadow banking system" to make mortgages, issue credit card debt, make loans for buyouts or private equity deals, then bundle those debt instruments and resell them as securities backed by the underlying assets. That enabled the institutions in the shadow banking system to leverage their capital over and over. (And because huge swaths of the shadow banking system escaped any effective regulation, it became the mechanism that turned a serious financial problem into a global financial crisis.)
The financial crisis has closed down some of these securitized markets. Others are functioning only because the government is acting as buyer when no one else will. But I'm sure this revolution has only been suspended. Securitization is simply too profitable and serves too big a market: Every pension fund, endowment, etc., looking for a higher return than Treasury notes and bonds offer. Exactly what form future securitization will take is impossible to tell right now. But I'd be willing to bet that companies such as Goldman Sachs (NYSE: GS) and BlackRock (NYSE: BLK) will be at the front in the next stage of this revolution.
I'd call the second revolution, especially in contrast to the securitization revolution, the poor people's revolution. Thanks to the success of microcredit in bringing banking services to the world's poorer people in the past decade, it's become clear that people with very low incomes use financial services to save and borrow, and that there's potentially a good profit to be earned in serving this huge market, if you can get the costs low enough.
A study by McKinsey and the Financial Access Initiative in October 2009 found that while 2.5 billion adults, just more than half of the world's adult population, don't use formal financial services to save or borrow, the 800 million people in Africa, Asia, and the Middle East who do use formal financial services live on less than $5 a day. Getting more services to that 800 million-strong market and expanding it to include some part of that 2.5 billion unserved market will require the invention of new forms of banking, whether it's the cell phone banking model of Africa or something else.
Companies worth keeping an eye on in this space include South Africa's Standard Bank Group (OTC: SBGOY), one of the first banks to partner with cell phone operators; India's HDFC Bank (NYSE: HDB), which is building out an ATM network into underserved areas of the country; Wal-Mart Stores (NYSE: WMT) in the United States and Mexico, which has again expanded its financial services effort; and Apple (Nasdaq: AAPL). The iPhone and its apps store seem to be an ideal platform for new banking products, at least as soon as Apple solves its AT&T network problems.
A few of these stocks—Itaú Unibanco, MetLife, US Bancorp and Wal-Mart—are already on Jim's Watch List on my blog. With this post, I'm going to add HDFC, Prudential PLC, Standard Bank Group, and Standard Chartered to that list. HBSC is already a member of my Jubak's Picks portfolio.
At the time of publication, Jim Jubak owned shares of HDFC, HSBC, Itaú Unibanco, Standard Chartered and US Bancorp.Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com