Now’s the time to increase exposure to financial stocks, CFRA says
Analyst firm CFRA hiked its rating on the S&P 500 Financials sector to overweight, attracted by an increasingly business-friendly Washington, economic fundamentals that suggest stronger loan growth and a stable pace of interest-rate hikes.
While Lindsay Bell, CFRA’s investment strategist, acknowledged that Washington news, especially tax policy developments, “certainly could drive some volatility,” she looks for “overall economic improvements, current valuations and momentum as primary upside drivers.”
Read: Bank stocks take flight as Washington signals regulatory rollbacks
Bank stocks have surged to their best performance in years this week as the presumptive next chair of the Federal Reserve, Jerome Powell, told Congress he believes banks are already regulated enough, and signalled an interest in reducing some of what the financial services industry considers a compliance burden.
Meanwhile, Congress is advancing a tax overhaul that, in addition to cutting corporate taxes, would likely stoke inflation. That’s because the plan will widen the federal deficit, pushing the government to borrow more.
Banks need a bigger spread between interest rates for short- and long-term borrowing to make money. When rates surged after Donald Trump’s upset victory in November, it was because investors expected that differential to steepen.
But the yield curve flattened after Washington gridlock stymied policy action for most of the winter, and recently it’s flattened even further. That’s worrying many investors, because if the yield curve flattens enough, it could invert, sending short-term borrowing rates higher than long-term ones. That’s traditionally a signal of recession.
“As economic activity increases and inflation rises, the curve should once again begin to steepen and support upside for the financials,” CFRA’s Bell wrote.
Even as the fundamental outlook looks rosy for financials, so does the technical analysis, she added.
Earnings estimates for 2018 for the financials have been raised, while those for the broader S&P 500 have been marked down. For sector earnings in 2018, growth of 15.2% is now expected, up from 13.4% in June. An increase of 10.7% is expected for earnings across the broader stock index, down from 12.1% over the summer.
Read: Pay attention to the flattening Treasury yield curve
On Thursday, the KBW Bank Index BKX, +1.20% had gained nearly 6% for the week, while individual bank stocks like Bank of America Corp. BAC, +1.51% were up nearly 7%. The Dow Jones Industrial Average DJIA, +0.78% was up 1.6% for the week even as it touched a fresh all-time high.