U.S. financials are among the best performing sectors since President Trump won the election, but has the landscape changed? Steve Biggar, Director of Financial Institutions Research, Argus Research, talks to Sara D’Elia about what’s driving the recent pullback in U.S. bank stocks and which names Argus has “buy” opinions on. Argus Research Company reports are available on TD WebBroker.
What are the biggest themes you're seeing in financials right now?
Well, financials are interest-sensitive vehicles, and they're economically sensitive. And clearly in the post-election period, what we've seen is a lot of euphoria for financials about deregulation that would help them. They've clearly had capital requirements that have-- the pendulum has sort of swung too far one way, and that would be very beneficial for them if they had less regulation.
Also, higher interest rates, both at the short and the long end, clearly they're sensitive to that as well. And economic growth, they are sensitive to that. Higher long growth, higher net interest margins would help them on earnings.
I mean, recently we've seen a little bit of a pullback. What do you think is driving that?
Well, that's true. The financials did extremely well in the post-election period. In fact, they were up about 26% between Election Day and March 1. And since we've seen a very large pullback. We're up only about 1% for financials so far this year, while the S&P 500 is up 8% or 9%.
So I think a big reason for that pullback, really, has been some of that euphoria that's come off financials. Some of Trump's agenda has gotten bogged down. The initial expectations about whether it's health care reform, tax reform, and deregulation, there's some question on timing and how long that will take to sort of move through. So that initial euphoria has sort of turned into some growth concerns.
Also, while the Fed is doing their part at the short end of the curve and increasing interest rates, the long end has pulled back. And some of the reasons for that, we had sort of a weak first-quarter GDP growth figure, and that has resulted in some pullback in the 10-year yield. And banks make money on the difference between the two, essentially. They lend-- they borrow short and long, so they make money on that difference. So the net interest margins have not exactly been as robust as we'd like to see.
And then thirdly, the capital markets activities, which you would expect animal spirits to move back, and clearly that was the case immediately after the election. But that's not translated into a very robust investment for initial private initial offering market, or fixed-income underwriting and equity underwriting market.
Now, let me ask you, in spite of that, you still have some buy recommendations as part of your research reports. It sounds like you like Bank of America, JPMorgan, and Morgan Stanley. Why those three names?
Well, each sort of has a bit of unique play. These are among the largest banks in the US, obviously. So we have regional buys as well, but in this large global bank space, a name like JPMorgan doing very well, we think. It's also consumer focused, more so than, say, a Goldman Sachs-- lots of credit cards, home mortgage lending. And they're also very active in the capital markets. So they're doing well in a number of fronts. And that's important, for a bank to sort of hit on all cylinders at any given time.
It's the diversification of their business that you like.
Very diverse, right. And another name, you mentioned, Bank of America. Now, this is a company that had quite a bit of trouble in the financial crisis period. They had capital problems. They had to cut their dividend quite a bit.
But all these numbers are sort of coming back for them now. They're very big in home mortgage lending. Of course, the housing market has come back. Credit quality has come back. They also have a terrific franchise with Merrill Lynch and the asset management side.
On the flip side, what are some of the risks with those names?
Well, again, going back to being interest rate and economically sensitive. That's probably one of the biggest concerns, is that rates don't move up, that they stay flat. And that's been a big concern of banks over the last many years, is that they've been unable to increase the net interest margins. They've been contracting.
Also, that the long end of the curve does not move higher, and that's an economic growth situation. Again, we had that weak first quarter. We expect a rebound in the second quarter for US GDP, but if that doesn't start to accelerate, that means long growth won't accelerate either. And that's another risk.
And credit quality is always a risk as well, that consumers or businesses start to have trouble paying bills. Particularly as rates start to move up, you have people on the margin that have home equity loans that are variable and tied to the prime rate, let's say, that will have more difficulty paying those loans back.
In terms of other potential areas of the market that you think look attractive or could benefit that are not direct financial names, what has you excited?
Well, a lot of names in the technology space that are sort of related to financials. And two hot areas right now I would point to would be fintech, or financial technology, and payment processing is also pretty popular right now. So a name like Fiserv that is a technology vendor to banks, that helps in payment processing and things like that with debit and credit transactions, that's a pretty powerful story right now.
Or a name like PayPal in the payment processing space as well, sort of like Visa and MasterCard, where you can transact using their service. You can use it online or in app or in store. You can pay and be paid. So payment processing is very hot right now. And to the extent that consumers use credit or ATM transactions over cash, they benefit from that over time. So those are two very hot sort of non-financial but related to financial areas.
Thank you very much.