Financials Sector Rating: Outperform
Financials sector overview
Federal Reserve rate hikes have helped the sector, which also benefits from current factors supporting loan demand, such as a strong consumer and corporate balance sheets. Additionally, a lighter regulatory environment should help, but a flattening yield curve could hurt the group.
Market outlook for the financial services sector
After some volatility the financial sector has regained its upward trend, posting the best performance over the past three months out of all 11 sectors. The continued belief that the regulatory environment will ease and comfort with the likely new Fed chairman appeared to us to fuel further gains. To those investors who have been frustrated with the group’s volatility, it will likely return, and for now we continue to urge patience as we continue to believe a tight labor market and solid economic growth should result in a steeper yield curve over time, which we believe would add to the positives we currently see in the financial sector.
Consumer and corporate balance sheets appear to be improving and are in substantially better shape than they were in 2008. Corporate cash balances are high and household debt service as a percentage of disposable income has fallen, although it appears to be stabilizing. Mortgage demand also appears to be healthy. Interest rates continue to be relatively low and the high rental rates in some areas of the country provide incentive for home buying.
We still have concerns, as changes in Washington are sometimes tough to come by and there has been some volatility in financial shares that could raise concerns among investors. However, with balance sheets solidified, financial companies have already been freed from some regulatory restrictions. Additionally, according to data compiled by Cornerstone Macro—the financial regulatory burden was reduced in 2017 and the trend looks set to continue in 2018.
Additionally, the negative interest rates seen recently in much of the world are reversing somewhat and the continuing move by the Treasury Department to rewrite some of the Dodd-Frank legislation could benefit the financial sector. We are watching all of these developments closely, as a sustained flattening of the yield curve, such as we’ve seen signs of lately, or foreign interest rates slipping deeper into negative territory could threaten our outperform rating.
We maintain relative confidence in the ability of the financial services industry to reshape itself and adjust to the changing environment, and believe now it is gaining the ability to do so, leading to our outperform rating.
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 too far, financials would likely struggle.
Clients can see our top-rated stocks in the financials sector.
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