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.
Market outlook for the financial services sector
The financial sector had been supercharged after the election as the prospects of a lighter regulatory environment, a steeper yield curve and the Fed’s recent rate hikes drew investors back to this long-shunned sector. We will see inevitable pauses and even potential pullbacks in the rally, but we believe these will be moves that refresh and will ultimately prove to be healthy developments for the group.
Consumer and corporate balance sheets also 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 quite 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, which could help bolster share prices.
Additionally, the negative interest rates seen recently in much of the world are reversing somewhat and the yield curve in the U.S. could steepen if inflation expectations accelerate, which should help to support loan profitability. We are watching these developments closely, as a sustained flattening of the yield curve or foreign interest rates slipping deeper into negative territory could threaten our outperform rating. However, we were encouraged by the recent earnings announcement from major banks that largely exceeded expectations and showed the continued resilience of the group.
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.
Clients can see our top-rated stocks in the financials sector.
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