Financials Sector Rating: Outperform

What is the financials sector?

The financials sector includes banks, thrifts and mortgage finance companies, specialized finance, consumer finance, asset management and custody banks, investment banking and brokerage, insurance, financial exchanges and mortgage REITs. 

Financials sector overview

Federal Reserve rate hikes have helped the sector, which also benefits from current factors supporting loan demand, such as strong consumer and corporate balance sheets. Additionally, the prospect of a lighter regulatory environment should help, but a flattening yield curve could hurt the group.

Market outlook for the financial services sector

The financial sector has been volatile as of late, largely reacting to changes in yields. The recent dip in yields and the flattening of the yield curve hurt financials, though they rebounded some when we saw modest rises in longer-term rates. To those investors frustrated with the group’s recent performance, we 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 may 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 recently that could raise concerns among investors. However, with balance sheets solidified, financial companies have already been freed from some regulatory restrictions. This should allow them to make better business decisions, as well as raise dividend payments and increase share-buyback programs, much as we saw recently following the announcement from the Federal Reserve that 34 major banks passed their stress tests. 

Additionally, the negative interest rates seen recently in much of the world are reversing somewhat and the recent 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:

  • Growing financial strength: Most financial institutions have paid back government loans and some are increasing share buybacks and dividend payments, illustrating their growing health and stability.
  • 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.
  • Reduced regulatory burden: The new mix in Washington could result 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 continue to shrink, financials would likely continue to struggle.

Clients can see our top-rated stocks in the financials sector.

Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare.

Schwab Sector Views

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Next Steps

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