In general, the share prices of financial companies tend to be less volatile than the overall market and this has proved to be the case during the turbulent first half of 2001.
Nevertheless, banking and insurance stocks have not been immune to bad news.
In Britain, the relatively small Independent Insurance has had to call in the receiver, as it emerged that it had seriously under-provisioned with respect to future claims. The company had a branch office in the Republic and a substantial number of small companies have been left without adequate insurance cover because of this collapse.
Also, the woes of the mutual Equitable Life have continued and the company recently announced a cut in its terminal bonuses of 16 per cent with respect to its British with-profits pension contracts.
The experience of these two companies is, however, exceptional and, in general, banking and insurance companies have produced solid returns so far this year.
Within the broad-based financial sector, some key themes and trends have emerged. Companies whose businesses are sensitive to the economic cycle have experienced considerable weakness in their share prices.
In particular, financial institutions such as Merrill Lynch and JP Morgan Chase have seen sharp declines in their profits and have warned about difficult times ahead. These companies are focused on investment banking and their earnings are very sensitive to fluctuations in the stock market.
Weak stock markets cut revenues from broking commissions and stock market trading. In recent years, investment banks have earned huge revenues from initial public offerings (IPOs) due to the booming technology, media and telecom (TMT) sectors. The bursting of the TMT bubble has led to a collapse in the IPO market and conditions seem set to remain difficult over the remainder of the year.
Another highly profitable area for the investment banks is merger and acquisition (M&A) activity. Typically in a downturn this form of corporate activity also tends to contract sharply and, not surprisingly, the first half of 2001 has seen a sharp contraction in the number and value of M&A deals.
The extent of the slowdown in M&A activity for this cycle has probably been exacerbated by the fact that so much business had been generated by the once booming TMT sector. The collapse in TMT profits and share prices has meant that much of this M&A activity has ground to a standstill.
The hugely acquisitive Vodafone Group recently announced that it would not be making any further acquisitions for the foreseeable future.
In recent months, several investment banks such as Merrill Lynch have announced further cost-cutting measures and staff reductions. However, there are limits to how deep these cost cuts can go without impairing capacity to deliver an adequate level of service to their customers. Therefore, profitability from investment banking activity is likely to remain under pressure for several more quarters.
In contrast earnings from retail banking have remained robust. Recent results from the US's largest bank, Citigroup, gave the market a positive surprise as the company reported strong returns from consumer lending and the sale of investment products to retail customers.
Irish banking stocks are focused on retail lines of business and have very limited exposure to capital markets businesses. This goes a long way to explaining the very strong share price performances from Irish financials over the past six to 12 months.
During the second quarter the share prices of all of the Irish financials rose sharply. AngloIrish Bank rose by more than one-third, followed by Bank of Ireland and First Active, whose share prices rose by 21 per cent and 19 per cent respectively.
Even if the Irish economy slows in the coming year, the defensive qualities of the Irish financials should continue to act to underpin share prices.
As such, the Irish financial sector should continue to be a relatively safe haven for investors in current turbulent stock markets.
