With the Fiscal Cliff Looming, Too Big To Fail is the Best Way to Invest
Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is no underestimating the impact that the "Fiscal Cliff" will have on the United States economy should it be actuated on Jan. 2, 2013.
The combination of $530 billion in Federal tax increases and spending cuts from the budget agreement is likely to send the economy back into a recession, according to a recent Congressional Budget Office report. As economic growth in the United States is declining with unemployment rising, it will certainly not take much to induce another recession.
Even if a deal is somehow reached before Jan. 2, which seems doubtful with the election in November, investors should look for a level of safety in stocks. The five major banks that are considered "too big to fail" offer this needed foundation for a portfolio.
Not only do Bank of America (NYSE: BAC), JP Morgan (NYSE: JPM), Citigroup (NYSE: C), Wells Fargo (NYSE: WFC) and Goldman Sachs (NYSE: GS) hold more than $8.5 trillion in assets, each has features that makes it an attractive holding. Each has surged from the nadir of The Great Recession, as the chart below shows.
Wells Fargo, Bank of America, and Goldman Sachs all carry the imprimatur of Warren Buffett. Wells Fargo is the second largest position in the portfolio of Berkshire Hathaway. Last year, Buffett invested $5 billion in the preferred stock and warrants of Bank of America. In the fall of 2008, at the nadir of The Great Recession, Buffett also bought $5 billion worth of Goldman Sachs securities.
JP Morgan is considered to be one of the best managed banks in the United States with Jamie Dimon at the helm. Citigroup has repositioned itself to profit from growth in emerging market countries. That is not a bad strategy: even during The Great Recession, the middle class in emerging market nations continued to expand. By 2025, according to a recent report from McKinsey & Co., the global consulting firm, consumer spending in emerging market countries will increase to $30 trillion, half the world's total. A rising level of affluence such as that among emerging market consumers will naturally demand greater financial services from institutions such as Citigroup.
In addition to the alluring franchise assets of each bank, there is also an attractive dividend income element. JP Morgan pays a dividend of 3.22%. For Wells Fargo, the dividend yield is 2.59%. The dividend for Goldman Sachs is 1.77%. Shareholders of Bank of America receive dividend payments at the rate of 0.49%. Dividends flow from Citigroup at a 0.14% clip. As dividend income accounts for about 40% of the historic total return of an equity, that is a critical component for investors, particularly in adverse market conditions.
While the share prices of each bank have recovered from the trough of The Great Recession, the valuations are still very attractive. The price-to-book ratio for Bank of American is just 0.39. Its assets are going for little more than one-third the book value based on its current share price. Citigroup sells at a price-to-book ratio of 0.47. At Goldman Sachs, the price-to-book ratio is 0.76. For JP Morgan, the price-to-book value is in that range, too.
The Federal Reserve recently issued an unusually clear statement that the economy of the United States was still in dire need of economic stimulus action from central banking authorities. As a result, a low interest rate environment will continue to be maintained. That is propitious for bank stocks.
For the five "too big to fail banks," the Federal Reserve statement also means that there are rough economic times ahead. That should increase the allure of these financial institutions for a variety of factors. Each survived The Great Recession. The commitment of the United States government to protect these banks, and the entire financial system, is unquestionable and unwavering.
Even if the Fiscal Cliff is averted or the effects mollified somewhat, the United States economy is still very weak. That is shown by the Federal Reserve having to buy US Treasury Bonds as no other investors, either foreign or domestic, will (hence the need for Quantitative Easing 2 and, quite possibly, Quantitative Easing 3).
It was a year ago this month that Standard & Poor's downgraded the United States. None of the fiscal factors having to do with that unprecedented move in the economic history of the United States have been rectified, or even improved.
In a recent interview, legendary investor Jim Rogers stated that, "2013 will be very bad. God knows what will happen in 2014." While it is irrational to expect any mortal being to accurately predict what will happen in the future, investing in "too big to fail" banks is certainly a prudent way to prepare based on the current economic conditions.
jonathanyates13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.