The flattening and inversion of portions of the Treasury yield curve this year has had a big impact on the Financials sector. Typically when the curve steepens—that is, when longer-term yields are higher than short-term yields—it’s helpful for financial institutions, which generally borrow at short-term rates and lend at longer-term rates. However, the reverse is true when the curve flattens or inverts, as it has done this year.
On the positive side, the string of Federal Reserve rate hikes between 2015 and 2018 have boosted interest income, even though the Fed has recently reversed some of those hikes. Financial companies’ balance sheets appear solid and dividend payments from major banks have increased.
However, there are challenges, as interest rates remain low from a historical standpoint, and the yield curve has flattened and inverted. Revenue has been increasingly tied to net interest income since the financial crisis and now those margins are shrinking. The Fed’s Senior Loan Officer Opinion Survey also has noted softening demand for certain types of loans. The record-high debt load held by nonfinancial corporations is a risk, but consumer and corporate balance sheets are in substantially better shape than they were during the financial crisis in 2008, leading us to believe the sector can avoid a repeat of the debacle seen in that period.
We maintain relative confidence in the ability of the financial services industry to reshape itself and adjust to the changing environment. For now, we continue to keep our marketperform rating on the group and to urge clients to remain patient.
The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:
- Outperform: likely to perform better than the broader stock market*
- Underperform: likely to perform worse than the broader stock market
- Marketperform: likely to track the broader stock market
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. Clients can log in to see our top-rated stocks in the Financials sector.
* As represented by the S&P 500 index
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