Where Are Financials Headed in 2018?
It has been a very good year for U.S. equity investors, as all the major averages reached multiple all-time highs in 2017. The S&P 500 ended the year up 21.83%, but as is commonly the case, there was a significant difference in the performance of specific sectors of the market. Investors who focused on money within the Technology sector were rewarded with returns of 34.28% during the year, whereas those investors who invested in the Energy sector lost 1.06%. Late in the year, as the price of oil rallied, the Energy sector did begin to rise, but only after substantial losses earlier in the year. So where do we think sector performance is headed in 2018? Here we highlight a sector that underperformed early in 2017, but has recently been a strong area of the markets: the Financial Equity sector.1
The Financial sector includes insurance companies, money center and regional banks, asset managers, and consumer finance stocks. There are a few common themes among stocks within this sector:
- They are generally highly regulated,
- With few exceptions, most Financials are dependent in some way to interest rates,
- Lastly, most Financials have positive profits, and thus, pay corporate taxes
While many sectors have highly variable and disparate company types, Financials tend to correlate. This can be problematic during a financial calamity, like 2008 and 2009, but in the current economic environment, there may be multiple tailwinds for this segment of the market.
- The regulatory environment has become less restrictive, as the Treasury Department is rewriting some of the Dodd-Frank legislation and rolling back some requirements. Furthermore, President Trump’s nominees for several key regulatory positions are pro-growth and pro-business and will very likely take a much less aggressive tone in interpreting rules, such as the annual bank stress test — which does not have specific requirements. It only mandates that it be conducted annually. Less regulatory burden will give banks more latitude to use their capital more aggressively, possibly boosting earnings for banks and other financial institutions.
- Rising interest rates are good for net interest margins for banks and better for insurance companies that need to cover liabilities with fixed-income assets. The Fed continues to raise interest rates, and the increased GDP output is also moving inflation somewhat higher. The 10-year Treasury yield has been moving higher which is also keeping the yield curve upwardly sloping. With ongoing economic strength, loan growth should continue, which has the potential to also help banks.
- Lower corporate taxes only benefit companies that actually make money, and particularly those that have earnings in the United States. Financial earnings are largely domestic, meaning they have been paying the high U.S. corporate tax rate, until this recent tax bill. Many companies will benefit from the lower tax rates, which will improve net earnings. Some of the biggest beneficiaries are in the Financial sector.
In conclusion, a strong economy is likely to increase loan demand, higher interest rates will lead to a better net interest margin for banks, and other financial companies, and a lower regulatory and tax environment will boost earnings. A decade ago, many companies within the Financial sector were on the precipice of a collapse; 10 years later, the balance sheets look better than ever, and now could be the time to buy into the Financial sector.
1. Bloomberg, as of 12/31/17.
The information and opinions herein are for general information use only. The opinions reflect those of the writers but not necessarily those of New York Life Investment Management LLC (NYLIM). NYLIM does not guarantee their accuracy or completeness, nor does New York Life Investment Management LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sale of any security or as personalized investment advice.
All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.
S&P 500 is an index of 505 stocks issued by 500large companies with market capitalizations of at least $6.1 billion.
There can be no guarantee that any projection, forecast, or opinion in these materials will be realized.
Marc Chaikin, Chaikin Analytics, and Chaikin Power Gauge are not owned, operated, or affiliated with New York Life Investments LLC or any of its affiliates.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities are distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors LLC is a Member FINRA/SIPC.