A current trader on the WhoTrades Marketplace has achieved incredible performance over the past year trading and investing exclusively in bank and payments stocks.Overall the portfolio has achieved a 71% yield with just a 5% drawdown. (Source: Marketplace Portfolio Page) The Merit Of Bank and Payments StocksPayments stocks are fundamentally strong businesses as they essentially collect a royalty on global economic activity, which is becoming increasingly electronic. Cost of goods sold (COGS) expense is virtually nil as they don’t deal with physical products, which produces high gross margins. The common criticism against payments and banking services stocks are that they’re highly pro-cyclical and dependent on strong economic activity in order to keep their valuations afloat. This is true to a large extent as stocks like Visa (V), Mastercard (MA), American Express (AXP), Bank of America (BAC), and Wells Fargo (WFC) have +63% to +75% correlations with the broader stock market if we cover the past ten years, or approximately one business cycle. If transactions volume doesn’t meet the expectations of what’s priced in by the market, then payments stocks are likely to underperform. Likewise, many banking stocks have introduced their own payments platforms as competition – or participate in a payments network such as Zelle – to increase customer retention rates. In terms of traditional bank lending businesses, which make up 32.6% of the portfolio, these are less dependent on the level of interest rates. Rather, they are geared more toward the spreads between borrowing costs and lending rates and the volume at which they lend at. Strong Performance Historically = Strong Performance Ahead? Over the past ten years, V and MA have returned 25% annualized, an impressive run considering this includes the financial crisis. AXP and WFC have both returned 8%-10%, which is in line with the broader US stock market. BAC has been flat despite having the highest annualized volatility of the bunch at 51%. Because V and MA have fairly lean cost structures, even if the economy declines, these payments providers are likely to remain profitable. Moreover, they contain little debt. Debt makes up just 5%-6% of Visa’s capital structure. For Mastercard, debt is only 2%-3% of the capital structure. This means most of the cash flow will go to shareholders and not to service principal and interest payments. V produced just a 31% drawdown during the financial crisis (the overall market was down 51% from November 2007 to March 2009). MA saw a 59% peak to trough decline, though primarily due to a solid run in the stock during the first half of 2008. From January 2008 to January 2009, the stock declined 35%, which is relatively mild considering the circumstances. Too Concentrated? A separate criticism of this portfolio might be that it’s overly concentrated in one sector and in one particular asset class. This means a higher level of idiosyncratic risk. Bank stocks and payments providers tend to be very earnings driven. So as long as the economy is growing and consumption is growing in particular, and the regulatory environment isn’t overly draconian for banks especially, these stocks will probably do well. Other stocks will tend to give you a bit of a different flavor to the portfolio and add some level of diversification benefit if different factors move their prices. For example, energy stocks, or those with commodity or natural resource related inputs more generally, out-performance will be dependent on capacity. When capacity has been flushed out of a certain commodity market, this is typically the best time to get in stocks of that specialize in its upstream operations (e.g., mining, exploration, production). The time to sell is when capacity begins to push up against demand and the market balances or even heads into overproduction. At the same time, there’s something to be said for investing in what you know well. Concentration in a particular asset class can be risky as each has its own environmental bias. The best time to buy stocks is when there’s a lot of slack in the labor market and central banks are keeping interest rates low – and perhaps buying financial assets to lower long-term rates and pick up market demand for financial assets more directly – all in order to get the economy going again. On the flip side, safe bonds will be prized during periods of low growth and declining inflation in an economy. Conclusion This trader on the Marketplace specializes in bank stocks and payments networks. His progress over the past year has been phenomenal with 70%+ returns with minimal drawdown. Nearly 60% of his portfolio is made up of Visa (V), Mastercard (MA), and PayPal (PYPL). V has returned close to 8x over the past 10 years. MA, despite being a household name for decades, has returned 40x in just 12 years, which is incredible. This is a more concentrated portfolio both in terms of asset class (100% equities) and sector. Nevertheless, it’s important to invest or trade in what you know and understand. If one’s specialty is bank stocks or payments providers and very good at this particular space, there can be value in picking winners and losers in a particular corner of the market. After such spectacular success over the past year, this trader may be worth following. Moreover, there are thousands of traders on the Marketplace where you can check out strategies of interest, track their progress over time, and generate trade ideas for your own portfolio.