IXG: Consider This Global Financials ETF On The Cheap (NYSEARCA:IXG)

It is well enough that people of our nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning. – Henry Ford

The iShares Global Financials ETF (NYSEARCA:IXG) covers close to 200 financial stocks across the globe. The focus here is mainly on banks, investment funds, and insurance companies that render financial services to both commercial and retail customers.

Recently, IXG has had to deal with a significant contraction in its AUM (down 23% over the past month), and this may prompt prospective investors to wonder if they are getting an attractive product at bargain prices, or catching a falling knife with further weakness ahead.

If you’re contemplating a position in IXG here are a few things to consider.

Even if IXG is a global ETF on paper, look under the hood and you’d notice that this is very much a US-centric product, as almost half the holdings are from that country alone, with Canadian-based stocks, a distant second (8% of the holdings). Unfortunately, the current sentiment towards US financial stocks is quite low, driven primarily by the troubles of Silicon Valley Bank, and Signature Bank. As noted in the Leaders-Laggers section of my subscription work, a chart measuring the financial sector’s strength as a function of the S&P500 has now dropped below its 20DMA for the first time since August last year. It also doesn’t help that influential rating agency- Moody’s has placed another 6 banks under review for a downgrade.

I suspect going forward, financial stocks with significant unrealized losses on their books, and a high threshold of uninsured deposits may be prone to more brutal sell-offs. If you’re interested in gaining more nuance and detail about the ongoing crisis, you may consider listening to a recent Twitter space discussion I had with Alasdair Macleod on Lead-Lag Live.

Admittedly a lot of issues are up in the air, and things go could either way, yet large swathes of the market are behaving as though the future path has already been ascertained. If you’ve followed my commentary over the years, you’d note that I’ve always highlighted the importance of staying agile and proactive when the crowd thinks it knows an unknowable future, as that’s when you typically witness opportunities with the highest payoffs.

If you’re a subscriber of The Lead-Lag Report, you’d also note that in yesterday’s paywalled report, I suggested the option of buying into the financial sector weakness. It would be premature to suggest that this is a systemic collapse, rather I believe risks are more idiosyncratic and are a function of sub-par risk management practices.

Besides at the end of the day, in a capitalistic model, you will always come across bad apples; defaults and bankruptcies are just an organic way of the system getting its act together. Lest you forget, the failures of SVB and Signature Bank aren’t something out of the blue. Data from Reuters shows that over the last 10 years, we’ve had years when we’ve seen a higher threshold of failures in the banking system.

Even if current developments turn out to be worse than expected, we’ve seen plenty of evidence in recent years that the government is willing to step in and prevent a total collapse. The Fed’s recent Bank Term Funding Program may also provide ample liquidity, eliminating the need for banks to cash is on their securities. This program will also limit the prospect of bank runs.

While I don’t believe we are facing a systemic collapse, structurally it’s fair to have some concerns about pursuing financial stocks considering the broader economic cycle in play. As noted in The Lead-Lag Report, housing-related financing has gone for a toss, and you will soon see this spill over to appetite for other forms of loans. Ryan Sweet the Chief Economist of Oxford Economics had recently come in for a chat on Lead-Lag Live, and he also expressed some concerns about the leveraged loan market.

In an uncertain economic environment, these financials will also devote a larger portion of their pre-provision profits to provisioning, thereby limiting the drop through to the bottom line. You’re also likely to see tighter lending standards, which will only end up slowing loan growth even further. Global financing conditions are still quite elevated relative to the mean, and this could cause debt distress further down the line.

Given the difficult financing conditions, other verticals that some financial stocks specialize in, such as deal advisory, and M&A could remain subdued. As noted in a tweet on the timeline of The Lead-Lag Report, M&A activity in Q1 already looks exceedingly weak relative to history.

Conclusion

While current conditions in the global financial space may be iffy, you do have an ideal opportunity to pick up this asset on the cheap. IXG currently trades at only 10.7x forward P/E, a significant 30% discount to a portfolio of diversified global stocks, as represented by the Vanguard Total World Stock ETF. IXG also offers you a pretty handy yield of 3.8% around 130bps higher than what you’d normally get from this product.

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