Financials Sector Rating: Marketperform
Financials sector overview
The sector has largely traded in line with changes in the yield curve as of late. With longer-term rates appearing to be capped and the Fed continuing to raise short rates, we continue to rate the sector at marketperform.
Market outlook for the financial services sector
The financial sector has been volatile over the past few months, largely reacting to changes in yield, performing better when the yield curve steepens and struggling when it moves in the opposite direction. Additionally, we believe that much of the good news, such as regulatory reform, is priced into the stocks in the near term. As such, we continue to believe that marketperform is the appropriate rating for the group, although it likely won’t be a smooth ride and there will likely be times of outperformance and underperformance that we think will roughly add up to marketperformance.
Consumer and corporate balance sheets appear to be improving and are in substantially better shape than they were in 2008, helping us to maintain confidence in the financial sector’s ability to avoid an outsized pullback. Corporate cash balances in many areas, such as technology, are high but we are concerned that the increased trade tensions may modestly negatively affect corporate confidence and result in delays in merger-and-acquisition activity, as well as perhaps depressing loan demand. Interest rates continue to be relatively low and the high rental rates in some areas of the country provide incentive for home buying, but we’ve seen declines in the Mortgage Bankers Association measure of mortgage applications, which could at least temporarily affect profitability.
We aren’t negative on the sector, just a little less positive than we were at the beginning of the year. We still believe the trend in the regulatory environment is positive, for example, but we believe the tailwind from such actions is declining, as it’s a story that seems to be largely priced in at this point.
There are still plenty of positives for the group, as Fed rate hikes have boosted interest income, balance sheets appear solid, and dividend payments from major banks have been increased based on announcements and payouts from some of the largest institutions as seen on FactSet. But as mentioned, the sector has seemed to trade more on the shape of the yield curve, and with our fixed income team believing flatter is more likely, it seems prudent to move to a more neutral view. Additionally, given the recent rise in mortgage interest rates, it’s possible the housing market could slow more, reducing even further the demand for new or refinanced mortgages.
We maintain relative confidence in the ability of the financial services industry to reshape itself and adjust to the changing environment, but believe now is an appropriate time to ease back a bit and have a more neutral position.
Factors that may affect the financials sector
Positive factors for the financial sector include:
- Modestly rising interest rates: Higher rates across the curve should mean financial companies can earn more on the cash they hold and the loans they make.
- Improving consumer finances: Reduced debt loads for consumers lowers the risks of defaults by that group in the coming year. Also, it gives consumers room to add to debt should they desire to do so, which it now appears to be happening.
- Reduced regulatory burden: The current mix in Washington is resulting in a lighter regulatory burden, which could increase profitability.
Negative factors for the financial sector include:
- Rapidly higher interest rates: Interest rates that move up too high or too fast could dampen demand for mortgages, which could affect profits in certain areas of the financial sector.
- Flattening yield curve: Should the spread between long-term and short-term interest rates shrink further, financials would likely struggle.
- Trade concerns: Corporate confidence could be dented, resulting in a lessening demand for loans and a reduction in merger and acquisition activity.
Clients can see our top-rated stocks in the financials sector.
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