The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund tracking the financial services sector, and rival financial services ETFs have recently faltered, but some analysts believe the fundamental case for bank stocks remains sound.
Capital levels at major U.S. banks are viewed as solid. Additionally, the Trump Administration’s tax reform effort is seen as a potential catalyst for the financial services sector, but it remains to be seen if that effort will come to life. Some industry observers expect the tax reform would help banks boost earnings in significant fashion.
“Financials entered the year seemingly poised for outperformance: After all, the group ended 2017 on a high note, and fundamentals have been improving, thanks to higher interest rates and lower corporate taxes,” reports Teresa Rivas for Barron’s. “However, since volatility shook stocks in recent months, those stronger fundamentals haven’t protected financials, and they’ve traded roughly in line with the market.”
Related: U.S. Sector ETFs for a Rising Rate Environment
Deregulation could also help the financial sector improve their margins. President Donald Trump has shown its eagerness in cutting back the red tape and remove some of the post-financial crisis regulations that has stifled the industry.
What Analysts Are Saying About Banks
Keefe, Bruyette & Woods’ Frederick Cannon “writes that we may have already seen most of financials’ outperformance vis-a-vis tech already, as those gains came early in the cycle,” reports Barron’s.
Meanwhile, the rising interest rate environment is also good for net interest margins for banks and more so for insurance companies. Given the latest strength in the U.S. employment data, many anticipate the Federal Reserve to hike rates at least three times this year.
Cannon is “still optimistic about financials; it’s time, however, to be more selective as there’s less opportunity for wholesale sector outperformance,” according to Barron’s.
The financial services sector is widely regarded as perhaps the only sector in the U.S. that is attractively valued relative to the broader market and its own long-term averages. The financial sector valuations still look relatively cheap, compared to the broader market. The sector’s valuations are still about 25% below the average since the early 1990s.
For more information on the financial sector, visit our financial category.