Analysts at Bank of America recommended clients remained overweight US financials, arguing that many investors were overlooking not just changes in historical trends for the sector but also multiple positives.
Their call came as the yield curve between the three and 10-year tenors inverted, meaning that shorter-term Treasuries were now yielding more than longer-dated debt issued by the Federal government.
Indeed, price-to-earnings multiples tended to move in lockstep with the curve, but that they said was an “overly simplistic reaction that ignores history and fundamental sector changes.”
For starters, whereas the correlation between S&P 500 banks’ earnings and the yield curve was 80.0% in the 1990s, since 2000 that had dropped nearer to 17.0%.
In fact, Financials had outperformed half of the time during yield curve inversions, the analysts added.
As for the risk of fee income drying up as corporate deal-making activity slows back to 2009 levels, well, since 2004, Banks and Capital Markets relative returns had had a low or even negative correlation with M&A trends.
And weren´t share buybacks slowing too? Yes, they had been, but cash balances had doubled since 2009 and with higher P/E ratios, Financials should be lauded for instead focusing on organic growth and dividends.
“Financials have generally timed buybacks better than other sectors like Tech. Plus, dividends matter more than buybacks for Financials – periods of dividend growth saw 5.5ppt 12-mth excess returns, whereas periods of net buybacks saw 1.9ppt excess returns in the sector,” BoA said.
And what about equity price volatility because of geopolitical risk? “Our factor work indicates that quality is the best hedge against a rising VIX, and Financials has morphed from a toxic, credit-sensitive sector pre-GFC into cash-rich one with low EPS volatility, thanks in part to Uncle Sam,” the analysts answered.
As well, Financials tended to outperform during periods of stagflation, albeit by less than Utilities and Energy.
As an aside, they also noted that hedge funds were near decade net-short lows while long-only fund managers had been underweight in the space since September 2018.
