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Financials Sector

Financials Sector Rating: Outperform

Financials sector overview

Despite continued Federal Reserve rate hikes and current factors supporting loan demand, such as a strong consumer and corporate balance sheets, the sector was struggling before finally moving higher over the past several weeks. A lighter regulatory environment should help, but concerns over a flattening yield curve appear to have hurt the group, we believe temporarily.

Market outlook for the financial services sector

The financial sector has been volatile as of late, largely reacting to changes in yields. The recent modest steepening of the yield curve, due apparently to rumors that Japan may be shifting monetary policy, helped to boost the sector out of its lackluster performance. To those investors who had been frustrated with the group’s performance, we urged patience and continue to believe a calming of the geopolitical concerns, a tight labor market and solid U.S. economic growth could 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 in many areas, such as technology, are high and household debt service as a percentage of disposable income had fallen, although it appears to be stabilizing. Interest rates continue to be relatively low and the high rental rates in some areas of the country provide incentive for home buying, although the recent softness in housing data and decline in housing affordability could dent mortgage demand, although it’s too early to make that call.

There are some other 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. Additionally, according to data compiled by Cornerstone Macro—the financial regulatory burden was reduced in 2017 and the trend looks to be continuing in 2018.

Additionally, the negative interest rates seen recently in much of the world are reversing somewhat and the continuing move by Congress to lighten up on some of the Dodd-Frank regulations could benefit the financial sector. We are watching all of 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.

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 further, financials would likely 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.

Consumer discretionary Consumer staples Energy
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Important Disclosures

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