Credit Cards: Safe Haven in the Storm?

But still, MasterCard and Visa are not completely immune to a downward economic cycle. Why is that?

No, they're not completely immune to an economic downturn, as a slowdown in spending could be enough to overwhelm the move from paper to electronic forms of payment and drive down growth rates. We have built in a modestly slower U.S. growth rate for 2008 and 2009 for both companies, though there is no evidence that the domestic slowdown is impacting other rapidly growing geographies around the world, such as Asia and Latin America.

American Express just announced the final settlement of its ongoing antitrust lawsuit against Visa and MasterCard, which it alleged were monopolizing the bank-issued credit card market. Discover Financial Services (DFS Quote) is due in court this fall for its showdown. Should Discover expect to see the same windfall as AmEx?

We do not believe Discover could earn the same level of compensation as American Express did. Since the bank system was opened up to American Express and Discover in 2004, many banks have signed on to issue American Express cards, as these cards offer better economics per transaction than the average Visa or MasterCard. Discover has not seen similar success in the bank issuing market, as economics on Discover transactions do not measure up, even to the traditional association cards. Therefore, we believe a court could deduce that demand just wasn't there for Discover cards, and that exclusion likely did not have the same impact as it did on American Express' business.

The one saving point we could see Discover arguing is that the Discover card could have been a more "general purpose" card than American Express, which clearly fills a high-end niche, and that the exclusionary tactics forced the company to lower its economics to compete for merchant acceptance.

Which is your top pick in the sector and why?

MasterCard. It's trading at a 7 multiple discount to Visa, the overhang of the AmEx litigation is behind them, they carry no credit risk, half of their business is outside the U.S. and we're expecting more than 30% earnings growth next year.