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Financials Sector Rating: Marketperform

Financials sector overview

The sector continues to track the slope of the yield curve, struggling recently as the curve has flattened and, at times, inverted. Volatility will likely continue, but with longer-term rates appearing to be capped and the Federal Reserve moving to a more dovish stance, we continue to rate the sector at marketperform.

Market outlook for the financial services sector

The financial sector continues to trade largely with changes in the slope of the yield curve. As the curve steepened, financials performed better, while the recent flattening has again led to modest underperformance. Financial institutions generally lend out at long-term rates and pay out interest at short-term rates. When that spread contracts, or disappears, the ability to grow those revenues can be questioned. However, we continue to believe that investors who need to add to financial positions should use these pullbacks to do so. We don’t believe we’re in for recession in the near term, which should allow financials to rally somewhat. We don’t necessarily think investors should load the boat at this point, but neither should they abandon ship. For now, we continue to keep our marketperform rating on the group and urge clients to remain patient.

Consumer and corporate balance sheets are in substantially better shape than they were in 2008, helping us to maintain confidence in the financial sector’s ability to avoid a repeat of the debacle seen in that period. Corporate cash balances in many areas, such as technology, are high, but we are concerned that the increased trade tensions may modestly negatively affect corporate confidence and result in delays in merger-and-acquisition activity, as well as perhaps depressing loan demand. We are also paying attention to the record-high debt load held by nonfinancial corporations (Federal Reserve, “Financial Accounts of the United States”). With good cash levels and low interest rates we aren’t overly concerned yet—but it is an area worth paying attention to.

We believe there are still plenty of positives for the group, as Fed rate hikes have boosted interest income, balance sheets appear solid, and dividend payments from major banks have been increased based on announcements and payouts from some of the largest institutions, according to FactSet. But there are certainly challenges, as interest rates remain low and, as mentioned, the yield curve has flattened over the past year. There also is the potential reining-in of loan demand as mentioned above. However, we don’t think these issues rise to the level of crisis.

We maintain relative confidence in the ability of the financial services industry to reshape itself and adjust to the changing environment, and are encouraged by the modestly better performance seen recently and are maintaining our marketperform rating on the group.

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.

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 remain inverted for some time, financials would likely struggle.
  • Trade concerns: Corporate confidence could be dented, resulting in a lessening demand for loans and a reduction in merger and acquisition activity.
  • Legislative concerns: With the Democrats in control of the House of Representatives, there have been comments by members that deregulation has gone too far and they may look to undo some the loosening that has occurred.

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.

Communications Consumer discretionary Consumer staples Energy
Financials Health care Industrials
Information technology Materials Real estate
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