Should You Cut Financials Out Of Your Portfolio?
If you want to fill somebody's stocking with the investing equivalent of a lump of coal, your top two choices may be Greek bonds or financial stocks. Both have spent another year underperforming the rest of the market, but it might be the financial stocks that have caused the most pain among investors.

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Sometimes good companies have underperforming stock, but in the case of the financials, that doesn't appear to be the case. In early December, Citi announced that it was taking a $400 million charge off for severance payments and other related expenses relating to a recent announcement that it was cutting 4,500 employees equal to 2% of its workforce.

Earlier in the year, Bank of America announced a 30,000 person layoff as it aims to cut $5 billion from its annual expenses. In total, more than 120,000 jobs are leaving the large banks.

Since July, Citi (NYSE:C) has seen its stock decline approximately 35% to a recent low just around $26, while Bank of America (NYSE:BAC) has seen shares lose half of their value, trading at just around $5.23. Financial Select Sector Spdr (ARCA:XLF), the widely traded ETF that tracks the performance of the entire financial sector has lost around 18% since July.

While the rest of the stock market has largely recovered from the 2008 and 2009 lows, the financial stocks haven't. Investors continue to speak optimistically, saying that the financials are largely undervalued relative to the rest of the market. With stocks like Bank of America routinely trading at or below its book value, these stocks should be a buy, but they continue to be chronic underperformers. (For related reading, see What Causes Stock Prices To Change?)

Why?
First, government regulation is making it harder to do business. In 2010, the Dodd-Frank law was passed, which carried a provision known as the Volcker Rule that no longer allowed banks to use their own capital to make bets in the market. With the advent of high frequency trading and other institutional investing, this segment of a big bank's business was a significant source of revenue. In fact, Citi said that the recent 4,500 person job cuts were largely from the closing of their proprietary trading units, because of the Volcker Rule.

Second, it's hard for investors to find a compelling reason to commit money to the financials. The sector has proven its ability to remain undervalued and since most banks still elect to pay big bonuses, instead of paying a dividend, investors would rather wait in other stocks that are paying dividends. (Check out these Solid Dividend-Paying Companies.)

How About 2012?
Going forward, the fundamental outlook for banks remains dismal. The European debt crisis could have a contagion effect on North American banks, as Europe attempts to break free from the chains of mounting debt. In addition, more non-bank friendly legislation in the pipeline and the still ailing housing market don't provide any good reason to commit money to these names.

The Bottom Line
With so many healthy investment opportunities presenting themselves in a recovering North American economy, investors may be best advised to steer clear of the financial stocks. The one bit of optimism may be that the 21st century investment markets have shown us that just when we think the coffin door is set to close, these companies spring back to life; however, good investors never invest on hope. (To learn more, read Stock-Picking Strategies.)




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