Frank from Dallas, TX asks: Mitch, I’ve read in a few places that investors should favor Financial stocks and banks this year. What are your thoughts on that, and if they’re positive, what should I buy?
Thanks for your question Frank, it’s a good one. I tend to agree that U.S. Financials could perform relatively well in 2017. I’ll give you two reasons why
The first is the possibility of looser regulations. The Trump Administration has signaled its intent to roll back regulations that could directly affect not only banks’ bottom lines, but also their approach to investment and risk. Trump appears poised to undo or simply not enforce some provisions of Dodd-Frank, which could give banks a bit more clarity as to what the rules of the game are. The less uncertainty that banks have, the more likely they are to inch back into taking more risk. And that’s a good thing.
The second is the yield curve. In the month following the U.S. election, bond yields on the long end of the curve soared. This steepened the yield curve considerably, which banks love. Remember, banks borrow money on the short end of the yield curve (overnight rates) and loan money out at longer-term rates, and then pocket the difference. A steeper yield curve implies higher net interest margins at banks, which means a more positive effect on earnings. As earnings go, stock prices tend to follow.
Now, that all being said, it is important to keep in mind that the market may have already priced-in both of the above expectations. After all, S&P Financials was the 3rd best performing sector last year, up +22.8%. The potential negative here is that if the Trump Administration does not manage to live up to the promises of looser regulation and/or if the yield curve reverses course, the positive case could unravel.
My guess, though, is that U.S. banks will have a better business climate in 2017 and will respond by increasing loan growth, taking a bit extra risk at the margin, and overall delivering solid earnings on the year.
As far as specific recommendations go, I cannot offer any in this space. But, I can tell you that Zacks’ domestic strategies have exposure to U.S. Financials and banks, so we are allocated in a way that we think will be opportunistic for 2017. If you want to learn specifics about sector/industry weightings and specific stocks, you can reach out to a Zacks Representative directly by calling us at 1-800-918-3114.
In the meantime, if you are looking for additional info on what you can expect from financials as well as what sectors and industries look attractive and which you should avoid, download our Stock Market Outlook Report. This report provides predictions on which sectors and industries look to catch fire and which to avoid. Learn more by clicking on the link below:
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