Sector Investing - Soar with banks, brokerages, and insurance companies June 4, 2001 Quote by Marc Singer, CFP Low interest rates and new laws will bolster profits. Here`s where to catch the action. By Leslie Kane Senior Editor Financial-sector mutual funds are helium balloons above a deflating market. In the past 12 months, the Standard and Poor`s 500 Stock Index declined 8.2 percent and the Nasdaq lost 37.1 percent, but financial-sector mutual funds gained 31.4 percent. *"This is an exciting time for a fairly boring industry," says Lanny Thorndike, chief investment officer at Century Funds in Boston. "Baby boomers` concerns about retirement income have made asset and pension management companies a vital and growing part of our economy." Moreover, the best is yet to come, says Diana Yates, a financial-sector analyst with St. Louis-based brokerage A.G. Edwards & Sons. "Lower interest rates and recent legislation make conditions right for the sector to pick up speed in coming years." When tech companies became supernovas, investors ignored slower-moving financial stocks. Now, the former tortoise is gaining fans. "Financial-services companies generally bring in a steady 15 to 20 percent growth in annual earnings," Thorndike says. "The sector`s considered a safe harbor, which is especially desirable in this nervous market." The financial-services category, which represents at least 15 percent of the overall stock market, includes three types of companies: Banks. Low interest rates act like a protein shake to banks, and lately the Federal Reserve Board has been slashing rates. "Rate cuts let banks lower their lending rates, which leads more consumers to take loans, which means more revenue," says Marc Singer, an investment adviser with SingerXenos Investment Management in Coral Gables, FL. "Banks can also increase the spread between the rates they receive and those they charge, increasing profits." The Bankruptcy Abuse Prevention and Consumer Protection Act of 2001, which the US House of Representatives passed in March, could also boost banks` bottom line. The Senate passed similar legislation, and President Bush will likely sign the resulting compromise bill. The new regulation will make it tougher for people to file for Chapter 7 bankruptcy, which forgives most of their unsecured debt. Instead, many struggling consumers will have to file for Chapter 13 bankruptcy, which requires them to pay off their debts. "This action can benefit banks and credit card companies, which bear the brunt when consumers default on credit card debts," says Yates. Last year, 838,885 nonbusiness Chapter 7 bankruptcy filings took place. Mergers will also help several major banks. For instance, Summit Bancorp combined with FleetBoston Financial in March of this year, and J.P. Morgan joined with Chase Manhattan at the end of 2000, to form J.P. Morgan Chase ."Consolidations promote lower operating costs," says Singer. "Previously, a town might have had three separate banks; now one bank may own all three, close down two branches, and control the same amount of deposits. It could take years to see returns from integrating formerly separate banks, though." What`s more, challenges remain. "Online and ATM banking have not caught on as completely as banks had hoped," Yates says. "Companies still have to keep brick and mortar buildings open, as well as offer online capabilities. That`s an expensive infrastructure." In addition, banks that rely on consumer loans may suffer if the economy worsens. More layoffs could mean fewer people will borrow. "However, fee-based banks, which get most of their revenue from asset management, will continue to do well," Thorndike says. Brokerages. These got a fuel injection from the 1999 repeal of the Glass-Steagall Act of 1933. The Act prevented any single company from offering securities, banking functions, and insurance services. Now, brokerages can provide banking services, and vice versa. "The wall is clearly down, and brokers will be able to operate as banks," says Yates. "Corporate clients like having their bank and brokerage under one house. This development can help increase business for brokerages." Still, the plunging stock market has stung discount and online brokers. "Brokerages haven`t lost clients, but the volume of trades has declined," Singer says. Brokerages with large institutional customers haven`t felt the same hit, however. "Institutions still trade regularly, and big, diversified brokerages, such as Merrill Lynch, barely feel the drop in retail investing," says James F. Catudal, a portfolio manager at Fidelity Investments in Boston. Insurance companies. Several factors look positive for this category. The Glass-Steagall repeal is one. In addition, insurance companies are buying brokerages and banks, giving them entree into a lucrative business that fits well with their operations. Because life insurance is a stable sector, it`s becoming more desirable as economic growth slows, says Singer. In addition, the tax-deductible limits on 401(k) plans may rise, which would help insurance companies that administer the plans. Also, as baby boomers transfer wealth to their children through insurance and investments, the life insurance group should benefit. Finally, insurers can earn from invested assets. "These companies control an enormous amount of money, and they can do whatever they want with it until they have to pay it out in claims," says Singer. That will give them an investing edge when the market starts to turn around. Because a sector fund has such a narrow focus, your stake in one should generally be no more than 10 percent of your portfolio. "However, the financial sector is traditionally less volatile than most; you could safely raise that allotment to 15 percent," says Catudal. Singer Xenos does not provide legal advice. Please consult with your own legal counsel.