Much has been made of the lack of value in the U.S. equity market, but the financial services sector has continually been highlighted as one of the last vestiges of value in this aging bull market.
Value hunters can consider ETFs, such as the iShares U.S. Financial Services ETF (NYSEArca: IYG) and the iShares U.S. Financials ETF (NYSEArca: IYF).
The Trump administration’s expansionary policies would be especially beneficial for banks since the segment is sensitive to the overall economy. Moreover, the expansionary policies have fueled bets of increased Federal Reserve interest rate hikes to rein in a potentially overheating economy and rising inflation, which further supports lending revenue and their bottom line among bankers and insurers.
Various data points suggest banks are indeed value plays.
“Banks and insurance companies make up around 26% of the S&P 500 Value Index, double their weighting in the S&P 500 Index,” according to a recent BlackRock note.
As conditions improve, the Federal Reserve will tighten its monetary policy to obviate an overheating economy. The central bank has already outlined plans to start winding down its trillion dollar balance sheet in October and left a December rate hike open.
Of course, Fed policy is a major contributor to price action in bank stocks and ETFs, such IYF and IYG.
“While both energy and financials are likely to continue to benefit from a rebound in value, each has its own idiosyncratic drivers. Not surprisingly, for financials, particularly banks, it is interest rates; and energy companies, the price of oil,” said BlackRock. “Starting with banks, as you might expect, banks benefit when long-term rates rise and the yield curve steepens. During the past two years, weekly changes in 10-year Treasury yields explained approximately 40% of the weekly moves in the Bank Index.”
Related: Financial Sector ETFs Unimpressed by Bank Earnings
Although the Fed has raised interest rates twice this year with another rate hike likely coming before the end of 2017, there are concerns about the central bank’s dovish tone and its impact on ETFs such as IYG. It is expected the Fed will boost borrowing costs one more time before the end of this year and that as many as three rate hikes could be on tap for 2018.
“In the U.S., energy and financials appear the best way to play the theme, but with the caveat that each is as much driven by their respective fundamentals as style preferences. The good news is that for now, what is good for value—firmer growth—is also good for rates and oil prices,” notes BlackRock.
For more information on the financial sector, visit our financial category.