The turmoil surrounding the collapse of several US banks in the past week won’t spill over to the rest of the sector and economy, says US Federal Reserve Chair Jerome Powell.

The Fed raised interest rates by an expected 25 basis points, which is smaller than previous hikes, and signalled rates may not need to rise as much as previously thought as tighter credit conditions weigh on inflation and hiring.

"These are not weaknesses that are at all broadly through the banking system," Powell said in his post-meeting press conference.

"This was a bank that was an outlier in terms of both its percentage of uninsured deposits and in terms of its holdings of duration risk."

It follows a tumultuous two weeks for global banks, with the collapse of several US banks and a massive Credit Suisse rescue deal which saw UBS buy its Swiss rival to restore confidence in the financial system.

As market fears surrounding global banking liquidity levels appear to ease, Morningstar’s chief US market strategist Dave Sekera says it’s an opportunity to find undervalued stocks “unfairly pulled down with the banking carnage”.

Is this an opportunity for investors?

Recency bias has investors fearing whether we’re facing the conditions of another global financial crisis, but Sekera says the situation is much different from 2008.

“Except for the rapidity as to how fast these stock prices have fallen, the current situation is much different from what prompted the 2008 global financial crisis,” he says.

“While there are negative economic and market consequences to this liquidity crunch, it will not result in a wholesale freeze across the financial system.”

The short-term downturn may provide investors an opportunity to take advantage of undervalued non-bank financial stocks that have been punished by the sector-wide selloff, he says.

“For investors that invest in individual stocks, this is an opportune time to look for stocks that have been unfairly dragged down with carnage in the financial sector,” he added.

How are ASX stocks reacting?

Much like in the US equity market, ASX stocks have taken a beating in the last month, with major ASX indices back down to their January levels.

Consequently, the Australian market is slightly undervalued, according to Morningstar’s market-wide price-versus-fair-value estimation.

Australian Market Valuation as of March 20, 2023. Source: Morningstar

Unsurprisingly, ASX finance stocks have been among the worst hit.

In the past three months, gross returns on the Morningstar benchmark Australian broad-market index are down 0.5%, compared to a 5.6% decline on the Morningstar Australian financial services index.

Morningstar benchmark Australian broad-market index compared to the Morningstar Australian financial services index

Where investors can find value

Investors should take caution before jumping in and buying heavily sold off financial stocks, particularly in a period of such uncertainty.

Sekera points investors towards two criteria: non-bank finance stocks “unfairly dragged down” by the market turmoil and companies with an established competitive advantage – or an ‘economic moat’ – that are well-positioned to recover.

“Many non-bank financials have very different business models than the banks and are not reliant on deposit funding. Examples include investment banks/brokers, asset managers, credit card providers, and financial technology,” he says.

“Focus your investments on high-quality companies such as those that we rate with wide or narrow Morningstar Economic Moats. These companies typically cannot only withstand economic stress but have long-term durable competitive advantages and may benefit from competitors that cannot survive a financial crisis or economic/market dislocations.”

A screen of the ASX finance sector reveals just three companies that meet both of Sekera’s criteria.

The highest-rated of the three, Australian investment fund Perpetual (PPT), already made our “3 stocks to consider if you’re buying the dip” list earlier this week.

Alongside Perpetual, two other stocks should be considered if investors are seeking undervalued, sturdy investments in the non-bank financials sector.

2 non-bank ASX financial stocks with moats

1. AUB Group (AUB)

  • Star rating: ★★★★
  • Fair Value: $29.00
  • Moat: Narrow

AUB Group, which has recorded a 5% drop in its share price in the last month, has otherwise posted a strong year-to-date performance.
Notably, Australia’s second largest general insurance broker network made Morningstar’s coveted Best Stock Ideas list back at the beginning of the year.

However, the company’s strong performance early in the year shrank the distance between its share price and fair value estimate and, by March 1, the stock had been dropped down to a three-star rating, meaning it was considered ‘fairly valued’ by Morningstar.

More recently, the difficult macroeconomic environment pulled AUB share-price back into four-star undervalued territory as of March 20, meaning the narrow-moat company is once again trading at a discount.

Commenting on the company’s recent performance, Morningstar equity analyst Nathan Zaia says AUB remains undervalued even if the company’s recently upgraded guidance proves ambitious.

“We believe AUB has earnings upside from its market position, customer and insurer relationships, acquisition strategy, and organic growth opportunities,” he says.

2. Pinnacle Investment (PNI)

  • Star rating: ★★★★
  • Fair Value: $11.00
  • Moat: Narrow

Down as much as 20% this month, narrow-moat investment management company Pinnacle has already bounced back around 5% since Monday.

Late last month, Morningstar held steady on its fair value estimate of $11.00 a share for Pinnacle despite a poorer than expected half-year performance impacted by higher expenditure.

At the time, Morningstar lowered its fiscal 2023 net profit after tax prediction for Pinnacle but held steady on the more positive outer-year forecasts. Morningstar analyst Shaun Ler says the company’s growth prospects are “bright”.

“Notwithstanding volatile markets and the abundance of competing managers, we still expect Pinnacle’s ongoing distribution initiatives, augmented by strong performance among its affiliates, to yield business wins,” he says.

Ler notes that among its peers, Pinnacle remains well positioned and benefits from a narrow-moat rating derived from—among other things—high switching costs and a strong industry reputation.

“Despite style headwinds adversely affecting larger affiliates like Hyperion and Resolution Capital, our analysis of Morningstar data still suggests at a group level, Pinnacle affiliates are outperforming benchmarks more consistently and at greater magnitudes than peers,” he added.