It includes banks, savings-and-loan companies, insurance companies, investment funds, brokerages, mortgage finance companies and mortgage real estate investment trusts (REITs).
The sharp economic contraction due to COVID-19 and extreme Federal Reserve stimulus—including slashing interest rates and buying Treasuries and mortgage-backed securities—has pushed interest rates dramatically lower. Lower short-term and long-term rates weigh on lenders’ net interest margin. Typically when the yield curve flattens—that is, when longer-term yields and short-term yields are relatively similar—it’s detrimental for financial institutions, which generally borrow at short-term rates and lend at longer-term rates. Topline revenue growth may prove to be elusive as regulatory burdens remain high, and areas like asset management and brokerage services suffer from severe price competition and low short-term interest rates.
However, if interest rates recover and the overall market continues to advance, the sector’s high sensitivity to equities would be a tailwind. Additionally, the Fed’s massive support of financial conditions could alleviate concerns about risk to banks’ balance sheets due to indirect exposure to leverage in the loan market. If expectations build for a quick economic recovery later in the year, we’d expect mean reversion from recent sharp weakness and an improved fundamental picture to provide a strong tailwind to performance.
Given that most of the recent risks that have come to light may already be priced into the market, we are watchful for some of the potential positive developments. In the meantime, our rating remains marketperform.
Sector Overview: Financials
Note: Each of the sector lenses shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or central bank policy changes.
Source: Charles Schwab, as of 05/21/2020.
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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